From the December-January 2008 issue of Treasury & Risk magazine

A Better Way to Default

Automatic enrollment is on a tear. After the federal government gave its blessing through the Pension Protection Act (PPA), a steadily mounting number of employers are signing up new employees automatically into 401(k)s to help them make sure they put enough away for retirement. But this also raises the fiduciary stakes for plan sponsors since most default options--the investments that participants are placed in when they fail to select one--have tended to offer only the lowest of yields, albeit accompanied by the smallest of risks.

The PPA took that into account too, by providing a working definition of qualified default investment alternatives, or QDIAs. And in November
the Department of Labor identified three types of investment funds that qualify under the PPA as safe harbors: target-date funds, balanced funds and professionally managed accounts.

So now it is up to plan sponsors to make sure their plans also make the grade, and not surprisingly employers and vendors are pushing forward to find or create options that will make employees happy that their companies signed them up."What's encouraging is that companies realize that simply automatically enrolling employees into the 401(k) plan will not get workers where they need to be in terms of retirement savings," says Pamela Hess, director of retirement research at Hewitt Associates. "They are shifting their priorities from basic enrollment to quality picking more appropriate default rates."

Initially, plan sponsors will move "out of super-stable value and money market funds into balanced funds that have a mixture of stocks and bonds--and more potential for growth," predicts Matt Smith, managing director of retirement services at Russell Investments.

But if you are not satisfied with what's out there, fear not, providers are starting to come forward with new funds specifically designed as QDIAs with an edge--meaning on the lower side of the risk continuum but with enough exposure to equities to bring some meaningful long-term returns.

"You are going to continue to see innovation with respect to products, and that's going to result in more choices, more sophisticated products, lower costs and new features, such as addressing longevity risk and inflation risk," says Phil Suess, a principal and defined contribution (DC) segment leader at Mercer Investment Consulting. "And you likely will see more and more of these products providing some sort of guarantees."

Among those out of the gate first: Barclays Global Investors (BGI) plans to offer SponsorMatch, scheduled to be available early next year. SponsorMatch bundles three portfolios into a single asset management strategy. The three portfolios being an annuity portfolio to provide an income stream, a beta portfolio to capture market returns and an institutional alpha portfolio for enhanced return potential. "It is a variation of a traditional defined contribution (DC) target maturity date fund in that it matches the participant's retirement year, but because it incorporates an annuity, it behaves more like a defined benefit (DB) plan," says Kristi Mitchem, head of BGI?s defined contribution group. "Plan sponsors can, in their capacity as fiduciary, provide a better retirement outcome for participants by directing the company match into a solution with DB like features.

Another differentiating element is that retirement values will be reported in income accrued terms rather than in total wealth terms." In other words, participants can at any time see how much annuitized retirement income they have earned per month for retirement and monitor the growth on a regular basis. Essentially, SponsorMatch turns the employer match component of a 401(k) plan into an investment solution that combines the best of DB and DC to provide a guaranteed income stream at retirement.

SponsorMatch differs from other funds that offer annuity benefits, because it is the first to make the investments a continuing part of the process. Other funds turn the payout into an annuity at retirement. And while that also guarantees investors won't go broke midway through their retirement, the products offer less chance to take advantage of growth opportunities. While annuities have gotten a bad rap in the past, especially over costs, consultants claim the new approaches aren't more expensive than traditional funds. Barclay's says it will charge 85 basis points for SponsorMatch, a fee on par with the cost of target-date and managed funds.

"It's an interesting approach," says Mercer's Suess. "I think you will see more and more products providing some sort of guarantee." The challenge, Suess says, is overcoming tradition by separating the employer match from the employee contribution in a manner not seen before. In the past, employers have invested their contributions in company stock, and the funds were commingled with the employee's. "That's a wrinkle that needs to be overcome," Suess says.

Another "interesting" approach, consultants say, is a new variation of Dow Jones Index funds designed to compensate for inflation. Set for launch at the end of January, the as-yet unnamed target-date offering will be a diversified portfolio of indexes that focuses on real returns, adjusted for inflation, according to Ronnee Ades, senior director of institutional markets for Dow Jones Indexes. "You hear enough talk about how you have to accumulate wealth, but not enough about preserving wealth," says Ades. The portfolio will be comprised of tried-and-true benchmark indexes for different asset classes. For example, the equity index folded into the portfolio is the Dow Jones Wilshire for U.S. investors. One thing that sets it apart from other Dow Jones index funds is the inclusion of Treasury Inflation Protected Securities (TIPs) as a distinct asset class. "TIPs are a meaningful hedge for inflation risk," says Ades. "We are going to see more and more included in target-date funds."

Meanwhile, there's more new and unusual investment options coming, consultants predict. Indeed says Russell's Smith: "We are on the verge of major changes in the complexion of the DC market."


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