The latest flavor in “do-it-for-me” 401(k) plans is being positioned for launch as plan vendors and sponsors consider doing the job of diversifying participant portfolios.
We’ve all heard of “do-it-yourself” investing. That was the idea behind the defined contribution retirement savings plans known as 401(k)s. But leaving investment decisions to employees — including just signing up for a plan — didn’t work very well.
To remedy that problem, some plan vendors and sponsors have tried to bring more participants and more assets into these defined contribution plans with “do-it-for-me” features like auto-enrollment, auto-escalation and auto-default into target-date funds. Today more than half, or 57 percent, of plans auto-enroll employees. Participation numbers rose to 75.8 percent of employees from 71.5 percent in 2006 when the auto-features were approved in the Pension Protection Act, according to Aon Hewitt.
So what’s next? Perhaps it was inevitable that the 401(k) world would now try to automate the next investment step by adjusting asset allocations as the need arises. The basic objective is to edge participants who are actively managing their accounts and not using target-date funds into the kind of diversified investment strategy that a target-date fund would have. This is generally done if portfolios are skewed too heavily toward one asset class, especially company stock. Owning too much of that has proven disastrous to hundreds of companies that were slapped with class-action lawsuits over the past decade.
“They want to capture participants who have not defaulted into a target-date fund or have a legacy asset allocation they may not be managing appropriately,” says Jeanne Thompson, a vice president of market insights at Fidelity Investments.
The trend is just beginning. Thomson says that fewer than 10 of the 20,000 plans that Fidelity administers are trying this sort of approach. Both State Street Global Advisors and BlackRock say they are conferring with clients about the idea, and the ERISA Industry Committee also expects to discuss the topic with members in coming weeks.
While the concept of automatic rebalancing an entire portfolio has been around for years, this focused approach “may be coming more to the fore because we’ve had all these auto-features,” says Dagmar Nikles, head of investment strategy for BlackRock’s U.S. and Canada defined contribution group.
Typically, Fidelity clients give their 401(k) participants 60 to 90 days to opt out. For those who stay in, Fidelity then moves the entire portfolio into a target-date fund, managed account or other customized allocation program, depending on what the plan sponsor chooses. The allocation will be automatically rebalanced after that.
However, other pension experts say that recordkeepers are more likely to divest pieces of the investor’s nest egg gradually, to avoid dumping assets onto the market all at once and driving down values. Besides, corporate management is hardly eager to encourage employees to shed their company stock in any form, for fear of sending a “sell” signal to the markets.
“To sell 20 percent of a company stock holding every six months seems like a way, in relatively speedy fashion, to reduce that concentrated risk,” says Fredrik Axsater, State Street’s global head of defined contribution investment strategy.
To some degree, this new idea is pushing people faster in directions they are already moving.
For instance, surveys by BrightScope, a San Diego–based ratings service, show that the share of 401(k) assets held in company stock has been steadily shrinking even without auto-diversification. It slid from 15.8 percent in 2007 to 12.5 percent in 2010 (the most recent figures available). But experts like Robyn Credico, director of defined contribution consulting at Towers Watson, say even that allocation to company stock is too high. “From an investment perspective, company stock is not appropriate, as it is undiversified risk,” she says. “And from a company perspective, you are increasing your fiduciary risk.”
And as long as employees are not professional money managers and don’t necessarily know how to choose investments, their employers will be looking for reliable ways to guide, nudge and compel them.
“Given the success of automation,” State Street’s Axsater says, “we should always challenge ourselves to think of other ways of using automatic features that can help participants.”