OREANDA-NEWS. January 15, 2016. The year 2015 was a busy one for retirement plan litigation. One of the most interesting cases was Sulyma vs. Intel Corporation Investment Policy Committee et al.—a case that involves the use of alternative investments in custom target-date funds (TDFs).

In the Intel case, a former employee filed a lawsuit against Intel's retirement plan, alleging a breach of fiduciary duty because of the inclusion of certain alternative investments—such as private equity, hedge funds, and commodities—in Intel's custom TDFs.

The plaintiff alleges that the Intel investment committee directed the custom TDFs to hold "extraordinary" concentrations of alternative investments. As a result of high fees (reaching as high as 136 basis points) and poor performance of these investments, the custom TDFs underperformed—primarily against certain proprietary target-date funds—by 400 basis points annually.

The Intel case is only in the early stages of litigation, and may not survive the myriad of legal challenges ahead. Additionally, the case involves "extreme facts"—that is, a heavy concentration in alternative investments and a fiduciary who chose to manage those investments internally instead of using an outside manager. These circumstances may not occur often, even among sponsors using custom TDFs.

"In contrast with this suit, most plan sponsors who have asked Vanguard about a custom target-date fund—or who use one already—do not manage them internally," said Gene Paranczak, a senior ERISA consultant and attorney in Vanguard's Strategic Retirement Consulting group. "Instead, they are managed by an independent investment manager who serves as a plan fiduciary under ERISA. Additionally, our clients who use (or are considering using) a custom target-date fund do not have a high concentration of illiquid investments, if such investments are used at all."

Additional fiduciary oversight

But if the case does proceed, it could provide additional insight into the process Intel went through in selecting the alternative investments and whether its committee had a strong, deliberative process for doing so. It also supports Vanguard's view that custom TDFs may have a level of complexity requiring additional processes of fiduciary oversight.

"The importance of the Intel case for sponsors revolves around the fiduciary responsibility for overseeing target-date funds," Mr. Paranczak said. "When our clients discuss custom target-date funds, we make sure they understand there is an oversight responsibility for them. The Intel case suggests that fiduciaries may need to be a little bit more cautious if they are considering custom target-date funds, especially if that fund will be handled by an outside investment manager."

Mr. Paranczak went on to say that sponsors who select custom TDFs and then decide to manage those funds internally may also be subject to more scrutiny and fiduciary pressure than sponsors who select proprietary TDFs. Potential questions may include:

  • Did your custom TDFs meet certain performance benchmarks?
  • Did you follow proper procedure in selecting and monitoring the funds?
  • What was your rationale for choosing your custom TDFs when proprietary, market-recognized TDFs with historical performance records were readily available?

The importance of diversification

Another factor in the Intel case is diversification. According to ERISA, one of the important duties related to asset management is adequate diversification of your plan assets. The fact that Intel had almost 40% of its custom TDFs in alternative investments could call into question its diversification strategy.

Even if the Intel case has legal legs, it's a long way to the finish line. But no matter what happens, Vanguard Target Retirement Fund product manager John Croke feels that sponsors should have very compelling reasons for choosing custom over proprietary TDFs.

"When the topic of customization comes up in conversation," Mr. Croke said, "we emphasize that moving from an off-the-shelf to a custom solution requires making a series of trade-offs between the perceived incremental benefits of such an approach versus the additional costs and incremental risk (both financial and fiduciary risk) required to potentially capture those perceived benefits. In the case of alternative asset classes like those in the Intel case, there are generally higher costs, less liquidity, and less transparency to both the plan sponsor and the individual investor."

Notes:

  • All investing is subject to risk, including the possible loss of the money you invest.
  • Diversification does not ensure a profit or protect against a loss.
  • Investments in target-date funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments (stocks) to more conservative ones (bonds and short-term reserves) based on its target date. An investment in a target-date fund is not guaranteed at any time, including on or after the target date.