I wrote a blog last spring on the use of custom portfolios in defined contribution plans. For background, custom portfolios are diversified multi-asset class investment options that are constructed from the individual funds that make up a plan’s investment menu. They typically take the form of a target-date or target-risk set of portfolios.
As discussed in that post, two drawbacks of custom portfolios are:
- Custom communications are necessary to support participant education. This can include fund fact sheets, general plan education material update, and plan website updates.
- Custom funds are more operationally complex than offering ‘off-the-shelf’ mutual funds or commingled funds. Depending on the plan’s recordkeeping vendor, the committee may need the services of a custodian/trustee to strike a daily net asset value and asset safekeeping services.
For these and other reasons, the use of custom portfolios by plan sponsors is limited. The 2018 PSCA survey of 403(b) plans showed that less than 5% of plans offered a custom target date fund solution.
To increase the use of custom portfolios, many recordkeepers allow plan sponsors to offer ‘model portfolio’ solutions to their participants. The major difference between ‘model’ and ‘custom’ portfolios is on the participant experience side. In a custom portfolio, the participant sees a single investment (e.g. ABC Plan Sponsor 2040 Fund) on their statement or the recordkeeper’s website. While the participant will typically see each of the underlying funds when reviewing statements or through the website.
If your plan’s recordkeeper offers a model portfolio solution, here are a few items to consider:
- Are the asset allocations for each portfolio pre-defined or customizable?
- If pre-defined - How were the models developed? Who developed them? Is the developer held to a fiduciary standard under ERISA?
- If customizable - Does the committee have the resources (internal or external) to develop the asset allocations? Does the committee have the time necessary to monitor the offering?
- Use of a custom portfolio solution can be difficult to unwind. Should a plan sponsor need to change recordkeepers in the future due to a service issue, pricing concern, merger, etc., the existence of custom portfolios can limit the candidate field.
- Use of proprietary fund options. Some of the solutions require the inclusion of assets classes that have only proprietary options available on the recordkeepers platform.
- These solutions are subject to change beyond the control of the committee and advisor. For example, if the recordkeeper hired a third-party investment advisor to develop the asset allocation glidepath. As updates are made to the asset allocation strategy, each committee has ceded control to the recordkeeper. Thus, a solution that appears to provide the committee greater customization than an off-the-shelf mutual fund or commingled fund remains subject to changes at the program level.
Ultimately, each committee will need to explore the benefits and drawbacks of a model portfolio solution. If you want to discuss the appropriateness of model portfolios for your plan, please reach out to your Multnomah Group consultant.
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice. Any views expressed herein are those of the author(s) and not necessarily those of Multnomah Group or Multnomah Group’s clients.