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Yesterday's proposed DOL regs underscore why default investments are the 401(k) market's giant untapped opportunity

Regulators' so-far soft approach on target date funds leaves door open for advisors to compete

Tuesday, November 30, 2010 – 4:35 AM by Elizabeth MacBride
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Michael Henkel: He is passionate about moving independent advisors into the retirement plan market, but says that for now, advisors lack the tools to succeed there.

In one more signal that regulators intend to take a hands-off approach to target date funds, the Department of Labor yesterday released a proposed regulation requiring plan administrators to offer more disclosure about asset allocations and risks in the funds.

The hands-off approach leaves the door wide open to advisors to seize what several experts said was a huge opportunity in the retirement market: selling against mutual funds’ target date funds, some of which have come under heavy criticism for performing badly in the financial crisis. Plan sponsors have increasingly been using target date funds as default options in their plans.

“Default options are the least exploited opportunity in the retirement plan market,” said Lou Harvey, president of Boston-based DALBAR Inc. “Advisors’ best opportunity with target date funds is to replace them with something better.”

In the wake of problems with target date funds, the SEC and the DOL have been working together to develop new regulations. The DOL’s proposal calls for target date funds’ marketing materials to include:

• The investment’s asset allocation.
• How that allocation will change over time, with a graphic illustration.
• The significance of the investment’s “target” date.

Here’s a link to more information: https://www.dol.gov/ebsa.

Ron Surz, a San Clemente, Calif.-based RIA, who has designed his own glide path, says that the new regulation looks like “boilerplate info for current prospectuses.”

The more aggressive plans

The DOL’s proposal stops short of the most aggressive recommendation in the SEC’s proposal. The SEC called for target date funds, or lifecycle funds, to incorporate their asset allocations into the names of the funds. There’s no sign of when the SEC, swamped by mandates put on it by Dodd-Frank financial reform, might issue its final regulation.

Nothing that the SEC does, however, seems likely to stop the juggernaut idea that people should be automatically enrolled in retirement plans, and that there should be default options that adjust fairly automatically.

Mutual funds have been out front of that movement, bundling their products into target date funds. At year-end 2009, nearly 10% of the assets in the EBRI/ICI 401(k) database was invested in target-date funds and 33 percent of 401(k) participants held target-date funds, according to the Employee Benefits Research Institute.

But awareness of problems and inconsistencies in the funds has grown. In 2009, SEC Chairwoman Mary Schapiro pointed out that the equities allocation in funds that operate under the label “target date” or lifestyle have equities allocations that range from 21-79% at their end dates.
Consumer advocates wanted the DOL and SEC to step in and create a definition of the range of assets allocations for such funds. Barbara Roper, director of investor protection, Consumer Federation of America, said she wasn’t surprised regulators seem to be moving away from doing so.

“Disappointed,” she said, adding that investors who default into target date funds likely need even more protection than average investors because they are likely to be among the least-informed about their options.

The questions swirling around target date funds – especially questions about the risk involved in the glide paths at the end – create an opportunity for advisors, agree industry experts.

They could devise glidepaths for their own target date funds, work with a more expert advisor to do so, or sell managed account services – another default option allowed by law.

Best opportunity: collaboration

“The best opportunity for the “average” advisor is collaboration with someone that is sophisticated enough to build custom Target-Date Funds that are superior to the off-the-shelf offerings,” said Phil Chiricotti, president of the Western Springs, Ill.-based Center for Due Diligence, an independent information firm serving the retirement plans industry.

“Advisors selling against Target-Date funds from Fidelity, Vanguard etc. could certainly position around the fact that NO vendor has the best investment manager in every category within each asset class. By building their own Target-Date Funds, qualified advisors may be able to outperform proprietary portfolios that are using inferior performers to fill the asset allocation matrix.

“Ironically, committees that eliminate individual funds due to bad performance might be buying the same funds back without realizing it by using the vendor’s Target-Date Funds.”

Only a few independent advisors seem to have jumped into the market, however.

Surz, who has a patent pending on the Safe Landing Glide Path, and he is working with Houston, Texas-based Hand Benefit Trust to manage their smart funds. He’s also selling his services to design custom glide paths.

So far, his fund has $50 million in it – a relatively small amount. He says it’s difficult to market his glide path in the face of the mutual funds’ marketing dollars.

In his path, equities are at 0% at the end.

He argues that plan sponsors first concern should be about safety, not maximizing return.

The golden rule

“First, don’t lose my money,” he said. “That should be the golden rule.”

Envestnet Asset Management is working on tools for advisors that want to sell into default space, said Michael Henkel, managing director of Envestnet’s Portfolio Management Consultants, though the project is on the back burner.

He formerly was the president of Ibbotson Associates, which pioneered the use of discretionary managed accounts in 401(k) plans.

He is passionate about moving independent advisors into the retirement plan market, but says that for now, advisors lack the tools to succeed there.

However, the opportunity is likely to keep growing as consensus around default options in retirement plans continues to build. Bob Reynolds, CEO of Putnam Investments, suggested in a speech two weeks ago that Congress should establish automatic IRAs for Americans who are not enrolled in employee-sponsored plans. If Congress adopted that strategy, he said, Americans should be automatically enrolled in target date funds.

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