Money Management Executive
So-called target-date and target-risk asset-allocation funds purport to make investing easier for 401(k) participants, but the proliferation of these products can make choosing the right one to offer a headache for sponsors.
According to the Investment Company Institute, there are more than 400 asset-allocation funds and their assets top $300 billion. Flows for target-date, or life-cycle funds, rose 50% in 2006 after a 57% increase in 2005.
Ninety-one percent of these assets streamed in from retirement accounts, such as 401(k) plans. If asset-allocation funds become the default investment of choice for automatic enrollment in accordance with the 2006 Pension Protection Act, the growth and market influence of these funds will only increase.
Yet comparing them is tricky, because no two funds are built alike. Two 2030 funds, for example, might have vastly different asset allocations, glide paths, and underlying funds.
"Everyone's aware that we're comparing apples to oranges here," said Lynette DeWitt, a senior research analyst at Financial Research Corp. in Boston.
The comparison gets even more complex over time if the funds or their underlying holdings change managers or strategies, dramatically shifting their direction as years pass. Such attributions make them unique among funds in that making accurate benchmarks for two funds with similar objectives — to allow an investor to liquidate at a retirement date of 2040, for example — is extremely difficult.
"These are truly dynamic," said Ronald L. Bush, managing principal at Retirement Research Inc. Partners in West Hartford, Conn.
That's not to say there is no interest in evaluating these funds vis-a-vis their competition.
"There is a real marketplace need for something," Mr. Bush said. The system would have to be simple, reliable, and, most important, credible, he said.
401(k) Advisors Inc., a retirement consulting company in Aliso Viejo, Calif., says it has devised just such a system to help fiduciaries, the industry's primary gatekeepers, differentiate between existing funds and choose those most appropriate for participants.
Unlike rating systems available from Morningstar or Dow Jones, 401(k) Advisors' Scorecard does not rank funds against one another; rather, the system assigns each fund its own score on a scale of 1 to 10.
"When these funds first came out, because of the type of due diligence we employ, we made it quite clear to the clients we deal with that there is no great way to benchmark these funds," said Jeff Elvander, 401(k) Advisors' chief investment officer. "The peer groups are ill-defined, and in some cases there are not enough peers in a group to make the analysis relevant."
Scoring is 80% quantitative analysis, including performance and holdings, and 20% qualitative, gauging things like expenses and service. To tackle the issue of future shifting allocations inherent to these funds, Scorecard uses a standard deviation calculation meant to measure performance risk rather than compare performance to industry sectors.
Funds with scores over 7 are considered "favorable," while those that earn a 4 or lower are tagged "poor." Funds that earn a 5 or 6, Mr. Elvander said, would be put on a watch list, and fiduciaries would be encouraged to monitor their performance and future scores.
401(k) Advisors has scored 80 funds, favoring those with a track record of five years or more. According to the company's analysis, only 40% scored 7 or better — some scored 10 — and 20% got a "poor" rating.
For fiduciaries, having such a scoring system not only helps weed out the unattractive options, but also helps to document the decision-making process that buttresses the plan's architecture. Even if funds are on a watch list, sponsors can document the reasons for their choices and their understanding of the products' potential shortcomings.
Monitoring the scores over time helps plan sponsors prove their continued diligence and defend their decisions to keep or change options as the score changes, Mr. Elvander said.
"What this score tries to accomplish is to identify the superior life-cycle and lifestyle funds," he said. "It gauges whether a manager adds skill or value."
Luis Fleites, vice president and director of retirement markets at Financial Research, said, "I don't know whether it would pass muster in terms of fiduciary responsibilities as a stand-alone factor in determining whether to select or to keep a fund, but it might be one of many due diligence efforts."
Mr. Elvander said the system has been well received by the plan sponsors he works with. In some cases poor-rated funds have even shifted course after seeing their Scorecard report, he said.
But the system faces some stumbling blocks. "A very useful, well-designed indexing or weighting system that doesn't have a name behind it is going to have a problem," Mr. Bush said in comparing 401(k) Advisors to the 800-pound ratings gorilla Morningstar. "That credibility is critical."
Another challenge is keeping up with the increasing number of funds. 401(k) Advisors' preference for funds with five-year track records severely limits the ever-increasing universe of such allocation funds. Fund companies like the set-and-forget message behind these funds, because it lends to automatically sticky assets, Mr. Bush said. The rollout rush that has preceded the Department of Labor's anticipated approval of these funds' suitability as default investment options has meant a flurry of new funds.
Mr. Fleites said the rating on 80 funds "is a very, very limited universe." Product pioneers such as Fidelity, Barclays, and Wells Fargo are likely to be rated for a while, leaving a much larger universe unscored.
Ms. DeWitt said she believes Scorecard is just the first in a coming wave of systems to evaluate target-risk and target-date funds.
"It will be quite a while before we have an industry standard," she said. "Someone has to develop a metric that can be a benchmark everyone can bounce against. It's great 401(k) Advisors has started the discussion."
