Now that the US Department of Labor (DoL) has defined which default investments for 401(k) participants are right, will employers’ lives be easier? Not necessarily. 401(k) pension plans’ sponsors are going to face delicate dilemmas about what is best for their employees among the three QDIAs (qualified default investment alternatives) backed by law: life-cycle funds, which become more conservative as investors grow older; balanced funds that buy both stocks and bonds; and professionally managed accounts in which investment choices are made using financial advisers.

It is true that under the Pension Protection Act of 2006 (PPA), if an employer chooses as default investments only the strategies approved by the DoL, the company can be shielded from liability for giving bad investment advice.

But employers still wouldn’t be “absolved from their responsibility to prudently select and monitor investment providers” and the fees they charge, says Bradford Campbell, a Labor Department assistant secretary. Moreover, they will be under pressure from the different industries’ lobbies claiming that one QDIA is more appropriate than the other.

Life-cycle or target-date funds are in pole position to win the race, according to many experts. Assets in these funds are now around $370bn (€253bn) or 11% of all 401(k) plan assets, up from $150bn at the end of 2004. Consultants with TowerGroup estimate that with the new rules these assets will grow to 56% of all defined contribution plans by 2011.

Target-date funds claim to be simple and efficient, because their exposure to equities varies from the highest level when participants are young to the lowest one when members age. So their strategy seems to fulfill the mission that the DoL established for QDIAs: to be the long-term investment solution for participants that have not elected an investment allocation and to include a “prudent” allocation to equity.

But critics say that life-cycle funds may differ a lot even if they have the same target. For example if you took a sampling of 2020 funds, you would find some with high equity exposure, 70% or more. They may also invest more or less in international compared with domestic equities, therefore their performance will be quite different. A recent trend has been the increase in risk taking by money managers: according to the consultant firm Hewitt Associates, today more aggressive target-date funds have equity allocations up to 94%, compared with 80% three years ago.

One reason may be that managers chased performances during the bull market, regardless of workers’ pension targets. When things go badly, a plan sponsor’s choice may be questioned by employees who are losing more money than another company’s workers invested in life cycle funds with the same target but better performances. Ultimately the sponsor will still face fiduciary liability.

Stable-value mutual funds attempt to mitigate this risk. These funds are essentially bond funds with a wrap, an insurance guarantee that protects against interest rate fluctuations, so they guarantee to give back the entire principal plus any accumulated interest. Not enough in the long term, according to the DoL which denied them the label of QDIAs.

However the DoL explains in the regulation that stable value may still be an appropriate default option for a 401(k) plan, and provides grandfather protections for assets invested in stable value as a default prior to the final regulation.

For example in cases where the plan sponsor considers participants’ human capital as a component of the optimal asset allocation, where participants are closer to retirement, and for participants that tend to be more risk-averse, in all these cases it may not be appropriate to use a default with potentially greater volatility.

At the moment stable value funds are included in half of employee-directed 401(k) plans, and represent approximately a fifth of 401(k) plan assets; Stable Value Investment Association members manage over $413bn (€283bn) invested in stable value funds offered in 110,000 defined contribution plans. One alternative is managed accounts, an investment service that allocates contributions among existing plan options to provide an asset mix that takes account of the individual’s age or retirement date.

“Managed accounts are increasingly becoming the default of choice due to their unique ability to automatically personalise portfolios for plan features and are in fact the only way to properly allocate a 401(k) portfolio in the presence of company stock or a cash balance plan,”, says Jeff Maggioncalda, president and CEO at Financial Engines, a provider of investment advice and managed accounts to 401(k) plans, with $15bn in managed assets.

One last complication regards managed account options that use computer-based investment programs constructed by a firm that has no direct relationship with the 401(k) plan: they are QDIAs only if their adviser is an Employee Retirement Income Security Act (ERISA) investment manager or the plan’s named fiduciary takes on fiduciary responsibility for the program.