Custom or Packaged? The Target-Date Choice Revisited

Many plan sponsors wrestle with the decision of choosing—or changing—a target-date solution. Is a packaged product appropriate for plan participants, or are there advantages to using a custom solution? Or is there perhaps another choice?

First of all, the fiduciary implication of choosing a target-date solution is clear: Selecting a target-date solution is a fiduciary act—whether it’s a packaged or custom version. Choosing a packaged option may seem less risky from a fiduciary perspective, but it also comes with many design and construction decisions baked in.

If the packaged solution is appropriate based on factors such as a plan’s asset base, demographics and saving behaviors, it may be the prudent choice. But for a plan with distinct characteristics, it makes sense to explore custom solution that can be tailored to the plan’s profile.

The Department of Labor, in its Tips for ERISA Plan Fiduciaries, recommends that plan sponsors explore both options before making a choice. Instead of assembling an exhaustive list, let’s take a look at some of the key decision points to consider.

What Does It Take to Get Things Up and Running?

Logistics are one aspect. Packaged solutions are generally considered easier to implement. Because they’re commingled vehicles like mutual funds or collective investment trusts, the recordkeeper can easily handle the implementation. Packaged solutions also feature a ready-to-go suite of participant communications, and have information that’s accessible to plan participants on third-party and the recordkeeper’s websites.

For plan sponsors with compelling reasons to think about customization, these aspects don’t have to be insurmountable. Custom solutions do have more operational complexity, and a plan sponsor must have the capabilities—or partner with the right providers—to implement and communicate them. But for plans with sufficient scale, custom typically comes at a favorable cost structure.

Who Controls the Investment Manager Mix?

In terms of design, the decision about who determines the underlying managers that drive performance is a major consideration. Some plans might prefer to rely on a packaged target-date solution, with the manager selecting underlying funds from its own lineup.

But some factors could tip the decision toward custom. For one thing, a plan may prefer to use managers in its core menu or defined benefit (DB) plan to manage sleeves of its target-date solution, too. This approach allows plans to take advantage of existing due diligence efforts—and perhaps greater asset scale to secure better pricing.

If a DC plan removes an underperforming core-lineup manager that also manages a sleeve in its target-date solution, it seems sensible to remove that manager from the target-date, too. For the most part, custom offers this flexibility. Some plan sponsors may also have views on deploying active and passive strategies: Packaged solutions can do this, but based on the manager’s judgement. Plans that want more control are generally on the path toward customization.

Diversification comes into play, too. Incorporating additional allocations to investments such as liquid alternatives can help dampen volatility and enhance risk-adjusted returns in periods when markets are volatile and expected returns are lower. But a broader allocation may be beyond the scope of—or at allocations higher than those of—existing off-the-shelf solutions.

How Tailored—and How Dynamic—Does the Glide Path Need to Be?

All glide paths adhere to the same concept: a more growth-oriented investment mix for younger participants that gradually de-risks as participants move toward and through retirement.

Off-the-shelf glide paths are designed for an average profile of participant demographics, saving behaviors and employee turnover. For plans whose participant universes generally align with this approach—and are expected to remain in alignment—an off-the-shelf solution may be suitable. If a plan has unique characteristics, on the other hand, a tailored glide path is likely to be a better fit.

Plan sponsors also need to consider whether their target-date choice should have the flexibility to adapt its asset allocation to changing market conditions and return expectations—as well as demographic shifts—over time. This is the case with custom glide-path management.

These are just a few of the considerations for plan sponsors when choosing between packaged or custom target-date solutions. Other factors to think about include the ability of a target-date solution to adapt to changes in a defined benefit plan’s status, as well as the desire to integrate a retirement income solution—both of which could lead to customization.

The Long View: Is There Another Choice?

Is there a middle ground between packaged and fully customized target-date solutions? We think there can be. As more and more providers offer custom solutions, the best practices from customization are able to inform better packaged solutions in the target-date space.

Some lessons that can be applied to packaged target-date options? The availability of multiple glide paths and managers, the separation of asset-allocation and manager-selection responsibilities and the incorporation of additional diversifying asset classes. From our perspective, providing plan sponsors with more choice is a path to better participant and fiduciary outcomes.

Jennifer DeLong
Managing Director—Head—Defined Contribution
Andrew Stumacher
Managing Director—Defined Contribution

"Target date" in a fund's name refers to the approximate year when a plan participant expects to retire and begin withdrawing from his or her account. Target-date funds gradually adjust their asset allocation, lowering risk as a participant nears retirement. Investments in target-date funds are not guaranteed against loss of principal at any time, and account values can be more or less than the original amount invested—including at the time of the fund's target date. Also, investing in target-date funds does not guarantee sufficient income in retirement.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

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