Which QDIA Is Best?

What’s more, McCabe argues, target date funds are “fully invested, which means they will experience downside volatility in bear markets, perhaps more so than many 401(k) investors can handle.” Participants may then lose confidence and opt out of a QDIA to an inappropriate investment choice, like a money market fund, he says. An actively managed account, on the other hand, “provides opportunities for the money managers to take cash positions to mitigate risks in a declining market, thus lowering volatility.”

Patrick Cunningham, managing director of Manning & Napier, an asset manager specializing in lifecycle funds based in Rochester, New York, agrees that “most lifecycle funds do not have significant risk protection.” Lifecycle fund “participants want risk management,” he says. With Manning & Napiers’s six collective investment trusts (CITs)–the firm’s target date funds–and four risk-based balanced mutual funds, “We have been able to protect our clients during bear markets and therefore better meet their retirement needs over time.” The next bear market will cause a “shake up” in the target date funds industry, Cunningham says, because so many of these funds lack a risk management component.

This is precisely why balanced funds make sense, says Chris Brown, portfolio manager of the Pax World Balanced Fund. “Balanced funds in general take a look at market risk and make adjustments for that while target date funds are just basically adjusting allocation based on one’s age,” he says. “Typically, a traditional balanced fund looks at the market and makes allocation decisions based on that; [balanced funds] are looking at ‘Does the risk/reward favor stocks over bonds or bonds over stocks?’” Whether a participant is “right on the cusp of retiring at 65 or [is] 35, the traditional balanced funds make a great core holding.”

But questions are still swirling around about how target date funds and managed accounts can be used under Department of Labor (DOL) rules, and DOL plans to issue further guidance by year end, says Ellen Goodwin, counsel at Groom Law Group in Washington. For instance, in the preamble to the DOL’s final rule on QDIAs, a QDIA is required to be invested in a blend of fixed income and equity products. But “with target date complexes, the funds for the young are all in equities and ones for the older [participants] would be all fixed income,” Goodwin says. As for managed accounts, the “programs basically have a manager invest assets among the available funds in the plan–maybe 15 to 20 funds–and the manager has some standard allocations for specific ages. Some of those funds impose redemption fees and transfer and withdrawal restrictions and these are problematic under DOL’s rules.”