Building better blends: Part 3 Aligning investment options with fiduciary responsibilities

In managing and selecting target date offerings for defined contribution (DC) plans, the fiduciary responsibilities of plan sponsors represent important guiderails. Employee Retirement Income Security Act (ERISA) standards require plan sponsors to consider both the costs and potential benefits of investment options for participants. That means a purely passive approach may not suffice. Courts have also held that plan sponsors may offer participants a range of investment offerings, including actively managed funds.

We believe a target date approach that combines both active and passive strategies can deliver the best combination of cost‑effectiveness and enhanced return potential. In this way, they help plan sponsors address their fiduciary responsibilities and, ultimately, help retirement investors along their journey to feeling retirement certain.

Investment options and fiduciary standards

Fiduciary standards require DC plan sponsors to exercise loyalty and prudence in selecting investment offerings and ensure that plan costs are “reasonable.” These requirements are not automatically satisfied by selecting the lowest‑cost option—e.g., some passively managed investment vehicles.

The ERISA fiduciary standards that apply to U.S. plan sponsors do not afford a safe harbor or heightened fiduciary protection when selecting between active and passive investments. Adopting an entirely passive approach to target date investing does not create an automatic defense from regulatory actions or lawsuits challenging fiduciary conduct, nor does it excuse a fiduciary from acting with loyalty and prudence when selecting investment options.

Fiduciary conduct is not evaluated in hindsight based on investment outcomes. The focus is on the diligent process by which plan offerings are selected and monitored. It must be prudent, informed, and—above all—exclusively intended to serve the interests of plan participants. This requires careful analysis of the advantages and disadvantages of the investment options available—both passive and active.

How a blended approach can help plan sponsors

A thoughtfully constructed target date solution can align with plan sponsor fiduciary responsibilities. In considering a target date solution, plan fiduciaries should balance the investment option’s risk and return characteristics with its cost. Also, plan fiduciaries should consider their plan’s unique attributes, including their employee demographics.

Our own target date solutions can align with the fiduciary standards that apply to U.S. plan sponsors. They seek to contain costs by employing passive strategies in asset categories identified as the most cost‑effective options and pursue active opportunities we identify as being the best opportunities to add value. Our solutions also consider a range of short‑ and long‑term risks, including market volatility and the danger of outliving retirement savings.

Potential trade‑offs exist between active and passive approaches across numerous capital market sectors. These include cost, excess return potential, and diversification potential, among other factors.

Our research has identified select passive strategies that can be more cost‑effective in some asset categories. Here, opportunities to generate positive excess return may not be attractive enough to justify the higher costs of active management.

In other market sectors, a purely passive approach was found to be unlikely to deliver the desired outcomes. Outcomes may be constrained by the limitations of the indexes available for tracking or where the passive approaches feature a tendency to deliver unintended and unwanted risk exposures. In these areas, active strategies have greater potential to add value for target date investors.

We seek purposeful diversification across equity and fixed income sectors, with a view to balancing costs and outcomes. In our view, this approach offers target date investors the potential for lower costs without sacrificing the opportunity to benefit from excess returns driven by fundamental research.

In our view, this design process—and the resulting portfolios—is supportive for DC plan sponsors as they seek to meet the fiduciary requirements that apply to the evaluation and selection of target date providers and products.

Conclusion

Our target date strategies can align with fiduciary responsibilities for selecting plan investment options. Plan sponsors have a responsibility to offer solutions that balance risk and return characteristics with value. Our target date strategies seek to do this by employing passive strategies in asset categories identified as the most cost‑effective and active strategies that offer the best opportunities to add value. Our process is rigorous and underpinned by in‑depth research, supporting the due diligence efforts of plan sponsors.