Could hyper-vigilance over investment fees inadvertently expose some plan sponsors to fiduciary risk?

Jason Bortz fears as much. An in-house Employee Retirement Income Security Income Act attorney with The Capital Group—which runs American Funds—Bortz says a decade’s worth of 401(k) litigation has made plan fiduciaries “very nervous.”

Many are rushing to passive investments, and passively managed target-date funds, to hedge against fiduciary risk.

But passive management is no guarantee of fiduciary compliance, says Bortz.

The prudence provision under ERISA requires plan sponsors to act solely in plan participants’ best interests.

In choosing passively managed TDFs simply for the purposes of reducing fiduciary risk, sponsors may be putting their own interest before those of their participants, an inadvertently failing their duties of prudence.

“Managing your own fiduciary risk doesn’t always equate to doing what’s best for participants,” said Bortz in an interview.

“Considerations like participants’ longevity risk and capital preservation are plan objectives sponsors have to try to balance if they are thoroughly considering participants best interests,” said Bortz.

In dismissing all actively managed TDFs based on fiduciary concerns, sponsors may be limiting participants’ ability to capture alpha through active strategies, says Bortz.

Toni Brown, senior vice-president of defined contribution at The Capital Group, says investment committees face considerable challenges and more moving parts than ever.

“Sponsors need to put the time and effort into understanding the design behind all of the TDFs the choose—passively or actively managed. Then they have to consider the needs of their participant base,” says Brown.

More sponsors are designing plans with a premium on successful outcomes for workers, says Brown.

Dismissing all actively managed options could work against that goal, she said.

Brown cites the downside risk in passively managed fixed-income strategies, which in some TDFs can account for more than half of a participant’s assets at retirement, as one potential area where a cheaper strategy may not be serving a participant’s best interests.

The prospect of rising interest rates could mean a substantial portion of one’s retirement savings is failing to keep up with inflation, potentially accelerating the already tenuous reality of longevity risk facing sponsors and participants.

“If a passive fixed-income strategy can’t adjust for duration, then there is potentially an issue,” said Brown.

“Fees are an important consideration, but sponsors are definitely facing a conundrum,” she added.

“A lot of participants will live for 30 years after they retire. That’s a long retirement to fund. For the most part they haven’t saved enough, so they are going to need continued growth after retirement, and that means equity exposure into retirement,” said Brown.

Those realities suggest sponsors have to consider the range of strategies, if they are to execute their fiduciary obligations.

Brown said American Funds has created an actively managed target-date strategy that changes the character of the equity allocation as the glide path nears, moving to less volatile equities that both pay and grow dividends.

Those dividends can help offset downturns in equity markets as retirement nears, and generate income into retirement, said Brown.

“There’s a misconception that some TDFs are completely passive, but the reality is whether or not the underlying funds are indexed, the decision to adjust allocation is an active decision,” explained Brown.

One more reason sponsors need to consider more than fees, and know exactly what’s under the hood of even passively managed TDFs when building investment menus in participants’ best interest.