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Portfolio Customization Beyond Target Date Funds

Target date funds (TDFs) have proven their value and efficiency. When installed as the qualified default investment alternative (QDIA), they steer plan participants into an age-appropriate, diversified portfolio. In a sense, TDFs turn participants’ well-known inertia from a disadvantage to an advantage: Participants can continue to largely ignore their accounts while leaving the TDF on autopilot and letting the fund managers determine a suitable glide path.

Seeking Customization

But TDFs have inherent limits, says Andrew Scherer, director of defined contribution at Russell Investments in Chicago. He notes that among existing TDFs, the asset allocation is based on national demographics of the average participant in a particular age cohort. Some consultants and plan sponsors want more customization for participants, however. “What we’re hearing from plan sponsors, from other fiduciaries such as consultants and financial advisors, is that there is an opportunity in the marketplace to move from an asset allocation that’s based on that ‘average or typical participant’ and drive that asset allocation down to a participant’s unique circumstance,” he says.

In late 2013 Russell Investments introduced its proposed solution to that need with its Russell Adaptive Retirement Accounts (ARA). The program is designed to qualify as a QDIA, but unlike TDFs, it provides customized participant allocations among the investment funds in a company’s 401(k) plan. It does this by collecting data in addition to the participant’s age from the plan’s recordkeeper, including account balance, contribution rate, salary and defined benefit plan data (if available). That asset allocation is adapted to market conditions and rebalanced quarterly, Scherer adds.

Participants can modify several key data inputs as a result of Russell’s collaboration with Envestnet|Retirement Solutions’ Qualified Individual Life Target Solutions technology. Using an interface developed by ERS, plan participants can add information to the ARA system to further customize the resulting allocations. The additional data can include outside assets and personal preferences regarding savings rate, retirement age, income needs and risk tolerance.

As of early October, ARA is live in two plans and in Russell Investments’ plan with roughly $350 million of assets. Plan sponsors Nyhart Actuary & Employee Benefits and Ingham Retirement Group have added ARA to their plan menus as the QDIA and conducted a re-enrollment for employees.

An Income Focus

As defined contribution plans have replaced defined benefit plans, one frequently cited problem is that participants focus solely on their account balances. That’s understandable: Account balance is the easiest metric to grasp, and having more savings is better than having less. The downside of that approach is that participants can fail to consider how their savings will translate to retirement income and possibly overestimate how much sustainable retirement income that amount can provide.

A key feature of the ARA platform is that it is liability-driven, says Scherer, essentially incorporating an approach used in defined benefit plans. “We’re solving for an 80 percent replacement rate of income of a participant’s pretax salary at retirement, which is a common standard,” he explains. “We hang our hat on the Aon Hewitt study but a common standard is the replacement rate of income that a participant would need to sustain their lifestyle in retirement.”

Plan Consultants’ Role

Russell Investments serves as 3(38) fiduciary on the program’s asset allocations and Scherer stresses that this makes the program complementary to consultants’ services. “One of our primary benefits that we foresee with this product is that we’re empowering financial advisors and consultants to accentuate one of their areas of strength and that’s the selection and monitoring of a plan’s investments,” he says.

There is no minimum plan size to adopt ARA, but Russell does want adequate diversification opportunities within the plan’s lineup. Among equity classes, they look for U.S. large cap, U.S. small cap and international, for example. Ideally, the plan will also have some sort of real asset class exposure and in the capital preservation area; they also look for intermediate fixed income and a short-duration option. Most core menus have these asset classes, Scherer notes. He says that the program’s cost varies by recordkeeper platform, but the goal is to price the service “at or below what the average fee of the target date fund in the industry today, which is around 74 basis points.”

With the growing emphasis on fiduciary best practices, Scherer believes ARA will appeal to sponsors seeking to combine a consultant’s skill at selecting plan investments with Russell’s fiduciary position, ability to create custom allocations and retirement income focus. “You’re serving your participant’s best interest in having them working toward an accessible outcome for their retirement,” he says.

TAGS: Mutual Funds
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