Designed to offer plan participants a simple, one-step investment decision, these funds allowed plan sponsors to address the needs of employees who lacked either the willingness or knowledge to construct a portfolio of the investment options available to them.

Today, target-date funds have moved beyond their infancy and into the forefront of defined contribution plan investment options. What we've learned so far about them:

>> They are popular.

In some plans, it's not unusual to see 75% of cash flow directed to target-date funds. Therefore, a fiduciary process of selection and monitoring, as required by the Employee Retirement Income Security Act, has become even more important.

>> Although they are simple, target-date funds are not simplistic.

Although the diversification of these funds may help maintain an appropriate risk level and simplify the investment decision for a plan participant, this does not mean there is no risk to the investor.

Simplifying the decision-making process doesn't make the investment itself simplistic.

>> They are difficult to evaluate.

Because they may use different allocation strategies, different target dates and different asset classes and fund types, effectively analyzing target-date funds versus an appropriate benchmark has proven virtually impossible.

Although tools for evaluating target-date funds are beginning to come to market, most still fall short of being able to demonstrate clearly to fiduciaries whether or not the target-date funds they are offering are sound.

>> Target-date funds assume all plan participants are the same.

Although the financial characteristics and needs of one group of employees can vary greatly, target-date funds are designed to be one-size-fits-all.

This simple approach makes it extremely difficult for plan fiduciaries to determine how well a particular target-date fund is addressing the needs of an employer's unique and diverse workforce.

>> Proprietary funds rule. A recordkeeper's proprietary target-date funds often were the first offered to plan participants.

Prudent selection from target-date offerings often was overlooked by plan sponsors.

The underlying funds within target-date funds traditionally have been an assortment of funds managed by the specific mutual fund family.

The plan sponsors, fiduciaries and plan participants have relied solely on the wisdom of fund managers in terms of the underlying asset allocation and investment strategy, and they generally have had no ability to affect any adjustments to these fund characteristics to meet the needs of their specific retirement programs.

Plan-specific asset allocation portfolios

Every employee population is unique, and employer-sponsored defined contribution plans should feature options that can be customized to meet each participant's individual needs.

One approach is to develop plan-specific portfolios based on the plan sponsors' own criteria, taking into account the specific characteristics and needs of the employees.

Typically, plan sponsors and/or their advisers spend a great deal of time analyzing, evaluating and selecting individual fund options to include in their retirement plan.

Once the fiduciary process is complete, the chosen funds should be available to those participants looking for a simplified asset-allocation solution. Plan-specific portfolios do just that.

Rather than being a proprietary set of target-date funds added to the plan menu, the next generation of asset-allocation portfolios can be designed to incorporate any number of funds that the plan sponsor has already deemed appropriate for its plan.

The asset-allocation models are customized from the plan sponsor's existing retirement plan menu, and the glide paths for asset allocation adjustments are built to meet the needs of their participants.

Participants now have access to professionally managed portfolios, and plan sponsors have provided options tailored to their unique circumstances through an appropriate fiduciary process.

The plan-specific solution also eliminates any concerns you may have surrounding comparison, allocation discrepancies and evaluation of the underlying portfolios.

Since the plan-specific solutions utilize the underlying funds of the plan, they allow fiduciaries to determine appropriate evaluation methods and glide-path strategies, without being limited by proprietary fund management.

Instead, plan sponsors can dictate how each target-date portfolio will be designed, ensuring that it meets the specific needs of their plan participants and adheres to the investment policies that they established for their plan.

In addition, a plan-specific solution provides greater integration of already existing investment options in the retirement plan menu.

For example, a broader spectrum of equity funds could be used to satisfy the goals of each predetermined investment portfolio, allowing for enhanced diversification within the portfolios themselves.

Perhaps most importantly, the approach can recognize and accommodate various employee considerations to be addressed, based on the intended use of the funds during retirement.

Plan-specific portfolios could incorporate strategies, such as retirement income funds, to provide guaranteed income and protection of assets for older employees who are nearing retirement age.

More regulations predicted to come

As the retirement landscape evolves, regulations for target funds likely will increase, leaving plan sponsors and plan fiduciaries with a significant challenge.

Having a more effective single-step solution will become even more critical for plan sponsors as more begin to adopt automatic plan features and utilize target-date options as a qualified default investment option.

The next generation of asset-allocation portfolios can be simple and straightforward without being simplistic.

They can preserve the convenience target-date funds offer participants while providing the level of oversight, evaluation and flexibility that plan sponsors require.

Bill Noyes is the vice president, client investment services at Diversified Investment Advisors, Inc., an investment advisory firm headquartered in Purchase, N.Y. Steve Smith is Diversified's vice president and corporate plans market leader. 

Advantages of plan-specific asset allocation solutions

>> More finely tuned glide paths

Allocation glide paths can be customized to more closely correspond to the characteristics and demographics of an employer's workforce.

>> More transparent cost and revenue

In sharp contrast to current target-date funds, the cost and revenue available to offset administrative expenses within plan specific solutions would be much more transparent and measurable, since the underlying funds already exist within the retirement plan menu.

>> Third-party expertise

A customized approach allows plan sponsors to partner with retirement plan advisors and consultants who can help construct appropriate plan specific portfolios - using criteria specifically set by the plan itself - and then independently monitor and report on the solutions. This level of objectivity can enhance fiduciary oversight and protection for plan sponsors. If the retirement plan advisor/consultant qualifies as an ERISA investment manager, the portfolios would qualify as a QDIA.

>> Greater flexibility

A customized approach allows allocations to additional asset classes and styles, designed to meet the needs of the individual participant population. In addition, the "common denominator" for individual investors can go beyond a single retirement year, and incorporate both the retirement year and the ultimate retirement income goal (taking a lump sum vs. continued investment in the fund after retirement). The funds could also reflect both the participant's retirement date as well as a preference for a greater or lesser level of risk.

>> Increased control

Plan-specific solutions allow plan fiduciaries to be more responsive to addressing fund performance issues, economic conditions and plan changes, as well as business or participant issues.