In the wake of the performance meltdown of many target date funds, a growing number of 401(k) plans are adding target risk funds to their lineup.
In the wake of the performance meltdown of many target date funds, a growing number of 401(k) plans are adding target risk funds to their lineup.
Last month, target risk funds saw overall net inflows of $430 million, quite a shift from September, when they saw $7 million in outflows, according to Strategic Insight/Simfund.
A year ago, 401(k) plan sponsors were rushing to use target date funds as their qualified default investment alternative for employees. Now, many plans selecting a QDIA are considering a target risk fund instead, executives said.
Unlike target date funds, which are designed to reallocate automatically to become more conservative as a participant's stated retirement date approaches, target risk funds are static. These investments attempt to expose the investor to a specified amount of risk and typically are labeled as conservative, moderate or aggressive.
Avatar Associates LLC, which constructs both target date and target risk portfolios, has seen 401(k) plan sponsors' demand for target risk funds outpace that for target date funds in the past few months, said Michael Case Smith, senior vice president for institutional strategies. “It used to be that 60% of clients wanted the target date and the rest wanted target risk,” he said. “Now that has flipped.”
OPPORTUNITY FOR ADVISERS
This shift poses an opportunity for advisers to work with 401(k) plans and participants. Employers that choose the target risk funds as a QDIA could use an adviser to counsel them periodically on whether the fund continues to make sense for the demographics of their work force, said Patrick Cunningham, a managing director at Manning & Napier Advisors Inc.
In October, a record net $210 million flowed into the firm's four target risk funds.
Advisers tend to prefer target risk funds over target date funds, experts said. Because they are static, it's easier to create portfolios around them.
“The fact that firms again are adding target risk funds to their plans means that there is an opportunity for advisers to not only work with the plan sponsor but also the plan participants,” said J. Ryan Forbrich, a certified financial planner with Financial Planning Services. “They can turn those participants into clients and have them after they stop working at those companies,” he said.
When the popularity of target date funds escalated a few years ago, many experts thought of them as a panacea for the 401(k) plan savings problem because employees could be enrolled in them automatically, and they would reallocate automatically as the plan participant got closer to retirement.
However, last year, many 2010 target date funds were severely overweighted in equities, causing participants to lose a good chunk of their savings.
Investment losses for these funds in 2008 were as high as 41%, with an average loss of almost 25%. In the wake of these losses, Congress, the Labor Department and the Securities and Exchange Commission are discussing regulating such funds.
As a result, a growing number of 401(k) plan sponsors that haven't yet chosen a QDIA are considering target risk funds, experts said. “While I am not seeing plan sponsors that have adopted target date funds get rid of them, I am seeing plan sponsors consider adding target risk funds instead of target date funds to their plans,” said Brian Hubbell, a principal with Hubbell Consulting LLC.
Five years ago, the ratio of requests for proposals for target date funds, as opposed to target risk funds, was 10-to-1, Mr. Cunningham said. “Now plan sponsors are starting to express concerns about target date funds, and many of them are revisiting the idea of using target risk funds,” he said.
John Hancock Funds LLC saw $114 million in net flows into its target risk funds last month, the second-best month ever for the firm.
“We had several 401(k) plans that began using our target risk funds in October,” said Keith Hartstein, president and chief executive of the fund unit. Hancock offers both target date and target risk funds.
Franklin Templeton Investments is seeing increased interest in its target risk funds from both 401(k) plans and advisers, said Peter Jones, president of Franklin Templeton Distributors Inc. The firm's three target risk funds experienced $400 million in net inflows in the first 10 months of the year, according to Strategic Insight/Simfund.
“Through the market downturn, some advisers were disappointed with their home office turnkey solutions,” Mr. Jones said. “They are now looking to our target risk funds as an offering for clients.”
Mutual fund companies are keeping a close eye on this uptick in interest in such funds, said Lynette DeWitt, a research director at Financial Research Corp.
HOST OF PROBLEMS
“I have had a number of fund companies call me asking if there is a pickup in interest in target risk,” Ms. Dewitt said. “I suspect that as we see regulation come down on target date funds, we will see more interest in target risk funds.”
If target risk funds continue to gain ground, advisers should make sure to reach out to 401(k) plan sponsors, because choosing these funds as the QDIA can come with a host of problems, experts said.
“Advisers need to make sure that a plan doesn't have a wide variety of ages and incomes among its em-ployees if they are going to choose a target risk as a plan's QDIA,” said Jason C. Roberts, a partner at Reish & Reicher. “If you have a bunch of highly paid 30-year-olds in a moderate risk-based portfolio, that could be trouble,” he said.
And while many plan sponsors are reconsidering target risk funds, these investments are far from overtaking target date funds as the prevalent fund option in 401(k) plans. Sixty-nine percent of 401(k) plans have target date funds as their QDIA, while only 10% of plans have target risk, according to Hewitt Associates LLC.
“Change in this industry is like turning a battleship,” said Kevin Price, chief investment officer of Interlake Capital Management LLC, who uses customized target risk portfolios with clients. “You don't turn in sharp corners, but the fact that more plans are looking at target risk again is good news.”
E-mail Jessica Toonkel Marquez at jmarquez@investmentnews.com.
