No one knows how long COVID-19 will impact the economy, but we can predict that lawsuits, including fiduciary breach lawsuits, will increase as a result of it.
In the 2008 financial crisis, target date funds (TDF) lost an average of 67% of their value, and today Bloomberg Law says that defined contribution plan investment in target date funds totals $1.4 trillion. Others put the amount of investment at $2 trillion and up. A Morningstar article reports that through March 20, 2020, target date funds lost on average 17% to 33% of their value, depending on projected retirement age. Though target date fund managers may have learned lessons from 2008 that limit the losses compared to 2008, whether the current market uptick will continue and when losses might be fully recouped are impossible to predict.
I have long recommended that 401(k) fiduciaries invest the time to understand the differences among target date funds and to carefully weigh their target date fund selections, including doing an actual request for proposals (RFP). (See the Cohen & Buckmann article, “Are Your Target Date Funds a Lawsuit Waiting to Happen?”). A federal court ruled in March that a lawsuit against Walgreens challenging its target date funds as imprudent investments may proceed, and there have been two other lawsuits filed in this area against Wells Fargo and BOK Financial challenging their target date fund selection since the COVID-19 crisis began.
COVID-19 may have accelerated a reckoning for fiduciaries who have not fulfilled their responsibilities for target date fund selection. Those who simply selected their vendor’s funds without investigation and financial firms that selected their own proprietary funds for their plans, especially funds without good track records, are probably most at risk. However, fiduciaries with exposure can begin to reduce that exposure by reviewing their selections and implementing a prudent review process. Here are some questions I am frequently asked about target date fund selection:
Aren’t These Funds Approved by the Department of Labor?
A common misconception is that because the Department of Labor designated target date funds as a qualified default investment alternative (QDIA) for participants who don’t make their own investment choices, selecting any target date fund is covered by a fiduciary safe harbor. However, the Department of Labor’s safe harbor does not relieve fiduciaries of the responsibility to prudently select and monitor their plan’s target date funds and to ensure that the fund fees are reasonable.
Aren’t These Funds All Similar?
There are off-the-shelf funds, which may be a managed selection of mutual funds, and custom funds, which are designed for a plan’s particular population. Target date funds differ substantially in their glide paths (how the asset allocation changes up to and even after retirement), underlying investments, management (active, passive or a blend), risk exposure and fees. For example, Morningstar looked at 8 prominent TDFs for participants expected to retire in 2020 and found that their equity exposure ranged from 8% to 55%. These funds may have substantial equity exposure long after the assumed retirement age. Since target date funds are essentially a fund of funds arrangement, there are fees for the underlying investments as well as management fees. Funds also differ in the extent to which they make investments in assets other than traditional equity and fixed income, such as real estate and hedge funds. A recent trend has been to combine target date funds with managed accounts as a hybrid arrangement. This combination permits more individualized investment management for participants approaching retirement. Given all of these choices, fiduciaries who have underperforming funds with above-average fees are a ripe target for plaintiffs’ litigation counsel.
What Can Fiduciaries Do Now?
Hire a professional fiduciary to assist with this important responsibility or consult with your professional adviser if you already have one. A 3(21) investment adviser can assist with expertise and recommendations, assuming co-fiduciary responsibility with the plan’s decision-makers. A 3(38) investment manager has delegated authority to make the decisions, leaving the plan decision-makers responsible only for prudent selection and retention of the manager.
Review and consult with your advisers now and regularly in the future. This situation is fluid. What seems prudent today may not be the right approach in the future.
Withdrawals from target date funds are up. Communicate with participants who may be panicking and considering liquidating their investments. Participants who locked in their losses by liquidating have impaired their chances of having adequate retirement income and may also be more inclined to sue. Without seeming to make investment recommendations or decisions for their participants, fiduciaries can explain the importance of diversified long term investments and educate participants about market cycles and having a long term perspective. While we are in uncharted territory today, general information about how these funds recovered after 2008 may be helpful.
Review your process for target date fund selection and oversight to make sure that it covers all fiduciary responsibilities or establish a written procedure for selection and oversight if you don’t already have one. Then follow the process set out in the procedure.
Keep good records of the reasons for any decisions made.
Nobody has a crystal ball to predict the best decisions in advance, but courts will not second guess fiduciary decisions that are made as a result of a prudent decision-making process.