How Plan Sponsors Make Sure Their QDIA Is Still the Best Option

Author: Noah Zuss

Date: 8/1/2023

View article on PLANSPONSOR

Plan sponsors Dawn Foods Inc. and the Southwest Airlines Pilots Association use different qualified default investment alternatives for their 401(k) plans, but they share several of the same practices to make sure they are looking out for their participants.

Employers review the defined contribution plan default regularly, performing quarterly examinations to fulfill their fiduciary duty under the Employee Retirement Income Security Act.

The Southwest Airlines Pilots Association reviews the performance of target-date funds used as the default in its 401(k) plan quarterly, both with its 401(k) plan committee and with an outside consultant, explains Mike Haynes, director of retirement at the Dallas-based union.

“We look at the performance of other target-dates relative to our target-dates as part of our due diligence, not only for the investments, but also for the QDIA,” Haynes says. “We compare them with the Vanguard target-dates on a regular basis, because when we selected our QDIA initially and our target-dates, it came down [to a choice] between American Funds and Vanguard, so we continue to monitor to make sure that that was a prudent decision, and it has been since 2016.”

As of July 26, the Southwest Pilots 401(k) plan held about $8.7 billion of participant retirement assets, with about $3 billion in the plan default, Capital Group’s American Funds target-date funds R6 share class, he says.

Plan fiduciaries also review the default option because it is a critical fiduciary duty to satisfy “the required due diligence for monitoring investment funds within the plan,” says Haynes.

Dawn Foods uses Empower Retirement-managed accounts as its QDIA, says Brian Coleman, vice president of total rewards at the Jackson, Michigan-based company. Participants at American Fidelity Assurance Co. are defaulted into Vanguard target-date funds, says Shawn Adams, vice president and human resources director at the Oklahoma City-based company.

Each of the plan sponsors has used the support of an outside partner to review the default investment offerings. Dawn’s default is reviewed by its investment adviser, UBS; Southwest Airlines Pilots’ default is reviewed by plan consultant Callan LLC; and American Fidelity Assurance Co.’s default is reviewed by investment adviser Cerity Partners, according to representatives for each plan sponsor.

Quarterly Default Reviews

Cerity reviews American Fidelity’s investments and plan default each quarter, grading “all of our investment options,” says Adams. The review is presented to the retirement committee by the plan sponsor’s investment adviser.

“The retirement committee is made up of senior people throughout the organization,” says Adams, who chairs the committee. “We have representation from our legal department [and] from different affiliates that are also part of the retirement plan.”

When plan sponsor default investments are reviewed, auditing must delve deep, because “RFPs don’t get to where you need to go,” in terms of fiduciary duty, Coleman explains.

At Dawn, several key aspects of the default investments are reviewed: fund fees, performance net of fees, fund management, any changes to portfolio managers, investment objectives, strategies and additions, and subtractions or alterations each quarter.

Funds with lower returns compared to peers or that are deemed to have deviated from the plan sponsor’s investment strategy are placed on a watch list, he explains.

After the review, the plan sponsor investigates why a fund underperformed and if lower returns are expected to be temporary or lasting, adds Haynes.

“Is it [because of] a managerial change? Is it something that’s [temporary]? Then we’ll watch [funds] for one quarter [or] two quarters and make a decision if we move forward,” Haynes says. “In some cases, it’s the fund is doing OK, but they went on watch because they changed management teams.”

American Fidelity Assurance Co. reviews the plans’ default investments for many of the same aspects as Dawn: “It’s a pretty extensive list,” Adams says.

At Southwest Pilots, the reviews during quarterly audits are similar, but the plan sponsor also relies on its consultant, says Haynes: “Some of the underlying holdings of the target-date funds we do review, because there’s different glide paths associated with the various vintages, [because] in the older vintages, they are more conservative, and so we do a dive into that area as well.”

He referenced specific TDF series—2025 and lower number vintages—for review in which participants are “actually very close to retirement or in retirement,” he says. “We do look at the underlying components of the target dates, [because] some of those individuals were defaulted” to TDFs early in their careers.

QDIA Comparison

Plan sponsors must compare their default investments based on the performance of products provided by competitor fund families or asset managers and what peer plan sponsors have selected, the plan sponsors agree.

Dawn Foods compares the plan and the default to similarly sized plans, developing a clearer understanding of performance against its peer group, says Coleman.

“How are you going to do your fiduciary responsibility without looking at [plans] of like size [and] what are their costs?” asks Coleman. Questions like, “How the plan is doing and what are the actual costs to each plan and how do they compare to the marketplace?” are critical.

At Southwest Pilots, the default investment offering is reviewed for the performance of underlying funds inside the target-date funds, measuring the TDF returns against competitors and other plans, explains Haynes.

Southwest compares the default funds’ risk-adjusted returns—the Sharpe Ratio—to peer funds over long-term time horizons because retirement planning is a long-term investment, adds Haynes.

“When we look at it, we don’t look at near-term returns; we look at, typically, five [years], seven or longer on the return history,” he says.

Examining returns without considering the effect of fees will create a blurred picture for plan sponsors, adds Haynes.

“We do look at look at costs [closely]: We look at costs on our investments and we look at costs on our target-date funds, but we have to remember that performance is net of costs, so you can’t strictly look at cost, because if you did, you would make the incorrect decision,” Haynes explains. “[Instead], you have to look at the net effect … that is a critical factor.”

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