Hybrids: the next generation of QDIA

Needs change over time
Needs change over time

Qualified Default Investment Alternatives (QDIAs) are a fairly recent invention (not quite 11 years old1) but have already become a central component of the corporate defined contribution retirement system. Although target date funds have been the most popular choice to date, recently-introduced hybrid forms of QDIA represent a notable new variation.


Different roles of each type of QDIA

In the latest issue of Russell Investments Communiqué, Holly Verdeyen describes the landscape:

“The PPA specified three main forms that a QDIA could take: balanced funds, target date funds (TDFs) and managed accounts. Each of these approaches has its strengths in different circumstances. For example, balanced funds are generally the simplest approach; managed accounts are the most customizable; TDFs (i.e., age-based options that automatically de-risk over time) are widely seen as the closest thing available to a ‘one-size-fits-all’ solution.”

Of these three types of QDIA, the early winner, by a large margin, has been the TDF. According to a Vanguard research note,2 “among plans designating a QDIA, 96% of the QDIAs were target-date options and 4% were balanced funds. less than 1% of plans had selected a managed account advisory service.”

But as time passes, those who were defaulted into QDIAs will grow older, and their needs will change, making the one-size-fits-all approach less effective. That can be expected to create more demand for managed account solutions and, Holly argues, this opens the door for hybrid solutions. Hybrid solutions start life as a simple and cost-effective balanced fund or TDF, and morph into a professionally managed account when the account balance becomes large enough to make additional customization worthwhile.

Holly explains that: “managed accounts are potentially the most powerful type of QDIA, in terms of the ability of tying the asset allocation to certain of the participant’s specific goals and circumstances.” And while that additional power may not be worth the cost or effort initially, when the sums involved are small, “as participants age and their account balances grow, the potential impact of professionally managed accounts also grows – a personalized and precise glide path for each participant that can be adjusted as needed based on progress toward his or her retirement income goal – without any hands-on action needed by the participant.”

Endnote 

Our popular Defined Contribution Retirement Plan Handbook, first published in 2014, has recently been updated and reissued. New material includes hybrid QDIAs, managed account solutions, fees and revenue sharing, outsourcing options, active/passive, and plan leakage.

The 2nd edition of the handbook can be requested here.


1 The concept of a QDIA was brought into being by the Pension Protection Act (PPA) of 2006, which gives plan sponsors protection against fiduciary liability for losses that are incurred in participant accounts provided certain conditions (including that the assets are invested in a QDIA) are met.

2 “TDF adoption in 2016,” Vanguard research note, February 2017.

 

 

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