Morningstar Magazine - June/July 2018 - 69

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0

This personalized advice, however, tends to come
with higher fees than target-date funds. Their low
fees have resulted in target-date funds capturing
most of defined-contribution plan assets.
Recently, there has been interest in "hybrid" QDIAs,
in which some plan participants (often younger)
are defaulted into a target-date fund series
and other (often older) plan participants with more
complex and less homogeneous circumstances
are defaulted into managed accounts.
Plan sponsors also are finding new uses for
retirement-managed-accounts engines.
Rather than managing investor assets, these
engines can be used to help plan sponsors select
the most appropriate QDIA. Under this new
use case, such engines determine the ideal asset
allocation for each participant; then, each
recommendation can be aggregated, providing
a data-driven, repeatable, documented process
allowing plan sponsors to stop guessing on
QDIA selection.
As recordkeepers, custodians, and payroll
providers have increased the scope of the data
they maintain, it has become much easier
to get a detailed view of a plan's participants.
A participant's age, salary, savings rate, balance,
and gender are far more meaningful than the
information gathered from a typical risk-tolerance
questionnaire. They provide a rich picture
of the participants and their capacity to take on
risk in pursuit of their retirement goals.
illustrates the process of taking available
data, passing it to the retirement-managedaccounts engine, and receiving an individualized
asset-allocation recommendation for a
given participant. In this example, the participant
is 50 years old and the recommended asset
allocation coming from the managed-accounts
advice engine is 70% equities. For context,
the exhibit also includes the three glide paths-
conservative, moderate, and aggressive-
of the Morningstar Lifetime Allocation Indexes.

20
EXHIBIT 2
Age

All Plan Participants Plotting the individualized plans of thousands of participants
is revealing. Any glide path will be too aggressive for some participants and too
conservative for others.
Individual Participant
Moderate
Morningstar Index:
Aggressive
Glide Path % Equity
Recommended
7

Conservative

Equity Exposure
Equity Exposure
100%
100%

75
50
15

20
30
Absolute Diﬀerence
Age
Source: Morningstar.

20
Age

50
25

0
25

0
30

EXHIBIT 3

Quantifying Goodness of Fit Using individualized recommendations, we can
quantify the misfit of a glide path and each participant's ideal asset allocation.
Morningstar Index: Conservative

Individual Participant

Equity Exposure
100%

14%
8%
7%

16%

75
15%

14%

26%

19%

E X H I B IT 1

Repeating the individualized analysis for a
hypothetical plan with thousands of participants
results in E X H IB IT 2 . It is easy to see how powerful
this comprehensive analysis could be for a plan
sponsor attempting to select an appropriate QDIA

Average Misﬁt: 12.2%

20
Age

0
40

Source: Morningstar.

based on participant demographics. An implication
of E X H IB IT 2 is that the only type of QDIA capable
of a unique asset-allocation recommendation
for each participant is managed accounts,
as any glide path will be too aggressive for some
participants and too conservative for others.
Moving from left to right along the age spectrum,
the bubbles representing the recommended
equity allocation follow a typical pattern in which

the equity amount decreases with age. Given this
pattern, it follows that a single balanced target-risk
fund would be inappropriate for a large percentage
of the plan population.
We can see that among the three Morningstar
Lifetime Allocation Indexes, the conservative glide
path fits this plan best, suggesting that the
plan sponsor should focus its target-date search on
more-conservative target-date fund families.

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Table of Contents for the Digital Edition of Morningstar Magazine - June/July 2018