carol@cohenbuckmann.com
Target date funds may be the ticking time bomb of ERISA litigation. In simplest terms, they are managed funds in which the mix of equity and fixed income changes over time as the participant nears retirement age and sometimes thereafter. They have underlying funds which may be actively or passively managed.
Although target date funds are very complicated, and have different risks, structures and fees, they have become the qualified default investment alternative (QDIA) of choice for most 401(k) plans. Despite the major differences among target date funds, far too few fiduciaries really understand how they work or evaluate their vendor’s target date funds against the available alternatives.
We have already had some lawsuits filed over target date funds. For example, Franklin Templeton settled a lawsuit challenging use of its own target date funds in its plan by agreeing to add a non-proprietary alternative and to have an independent investment consultant do the search. Just within the last few days, we have had a lawsuit filed against Principal claiming that its target date funds, which are separate account investments treated as holding ERISA plan assets, were more expensive and had worse performance than competitor funds that tracked the same financial index. The suit also claims that Principal profited by receiving an extra layer of fees by using its own underlying funds. A lawsuit was also filed against Walgreens seeking restitution of $300 million because the plan had target date funds that allegedly performed worse than 70 to 90% of peer funds.
If fiduciaries have any doubt that these funds are in the crosshairs, they should take a look at the website of litigation firm Cohen Milstein, which has a whole section titled “Investigation of Target Date Fund Investments.” Cohen Milstein says it is looking at four factors-
Improper Investment Strategy-Are these funds riskier than disclosed?
Excessive Fees
Self-Dealing, such as by using the sponsor’s own funds
Improper Default Elections-Are the default funds prudently selected?
What can company fiduciaries do to protect themselves? The most important thing is to never automatically select your vendor’s funds without investigation. Here are some additional suggestions, which will probably require consulting an investment adviser and your ERISA counsel for assistance-
Understand the basics of how these funds work and the fees payable, including those for underlying investments.
Study the underlying investments. Some target date funds can include alternative investments such as real estate and some will continue to alter the mix of investments after the assumed retirement age.
Understand the risk profile of the investments. Make sure that it is appropriate for your participants.
Benchmark your funds for performance and fees.
More company fiduciaries should consider doing an actual rfp for their target date funds. I wrote this column https://401ktv.com/rfp-target-date-funds/ for 401ktv explaining how to do it.
It is equally important to document the steps taken to evaluate the selected target date funds so that there is a record to point to if a lawsuit is filed.