Private companies that create value have five things in common: They have a strong culture, a specific strategy, clarity in their business model, quality people and they meet certain financial markers that indicate whether the organization is successful, says Mario Vicari, director in the Audit & Accounting Group at Kreischer Miller, Horsham, Pa.

“Decisions about who you are as a company, how you compete, your market position, how you organize your business model and the quality of your team are key factors in creating value for private companies,” says Vicari.

Smart Business spoke with Vicari about how these factors drive value and how private firms can position themselves to attract and retain capital.

How does a company’s culture impact its value?

Every company’s view of its culture is different, but ultimately, key leaders should answer these questions: What are you passionate about? What makes you different from other companies that provide similar products or services? What really matters to you at the end of the day? And, how do you make your core beliefs clear to employees? In essence, how do you walk the talk?

Culture and core values set the foundation of the firm and drive high-level decision making. Without knowing who you are and why you exist, a company lacks direction and has a difficult time gaining buy-in from stakeholders, including employees, vendors, clients and end-users. Before you can build a company, you must know what you believe in and who you are.

The highest-performing companies have this written down, and communicate it and live it with their employees. A strong culture is what binds the company together and makes it unique.

Where does a company’s strategy come into play?

A business must know its position in the market and how it can best serve the right customers. How will you compete in the market? What is the definition of a perfect customer for your business? How will you differentiate your company from others in your space? Will you compete based on price or value?

A company’s strategy is often linked to its history and has to do with its core strengths. Identifying what you are really good at and focusing on markets that play to your strengths are critical. Also, the best companies are crystal clear about the definition of an ‘A’ customer and focus like a laser on that target customer. Part of determining positioning is to identify the specific markets and customers you will serve.

It is important to be discriminating in making these choices. The best companies know that they can’t be all things to all people.

Why is the business model important?

The business model represents the way the company organizes itself to fulfill its strategy.  Ultimately, a business model answers the question, ‘How will you uniquely fulfill the promise of delivering value to the marketplace?’

It is about how the company organizes itself to execute its strategy. Do you fulfill the promise of what your culture says you should be doing, and how do you fulfill the promise you make to your customers? Once you know who you are and how you will compete, the business model outlines how your people and processes will achieve company objectives.

A business model is the coordination of activities within the business that addresses how you will go to market and deliver value to the customer.

How does a company get its people on board with the culture, strategy and business model?

Behind every strong organization is a group of talented leaders — a team. Often, private companies that don’t grow are hampered because the CEO is the smartest person in the room; they don’t hire people who are better than themselves.

In the best companies, CEOs surround themselves with very high-level skills in critical parts of the company and allow these people to lead.  Companies that create value are constantly assessing whether they have the right people in the right positions in the company, and whether each person is delivering his or her maximum potential.

Strong company executives make tough decisions when people aren’t performing. A business cannot execute plans without really strong people, and great companies are not afraid to make a change if key people are not measuring up.

What financial metrics indicate that a private company is creating value?

Ultimately, margins and cash flow drive value. These metrics indicate whether a company has strength in pricing and whether it is managed efficiently. If good margins and returns on sales are produced, the cost structure is solid and the business is likely in a niche where it can compete on a value proposition and not solely on price.

Other metrics that are important reflect efficient allocation of capital — return on equity and return on assets. The best companies can do more with less, and they are careful about allocating capital to get the highest returns on their assets and equity.

Capital is scarce and hard to create in private companies, which is why it is so valuable. The private companies that create the most value are discriminating in their capital allocation decisions.

Mario Vicari is a director in the Audit & Accounting Group at Kreischer Miller, Horsham, Pa. Reach him at (215) 441-4600 or mvicari@kmco.com.

Published in Philadelphia

It has been touted as the most significant financial reform since Franklin D. Roosevelt’s New Deal.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, created in response to the financial crisis of the last few years, was signed into law almost one year ago. While not all of its 387 rules have been adopted, the scope of reform will affect investment advisers, investors, business owners, management and the public for years to come.

According to Todd Crouthamel, a director, Audit & Accounting, and a member of the Investment Industry group at Kreischer Miller, Securities and Exchange Commission chairman Mary Schapiro said, “The purpose of the legislation is to create a more effective regulatory structure, fill regulatory gaps, bring greater public transparency and market accountability to the financial system, and give investors protections and input into corporate governance.”

“By the time it is fully adopted, the Dodd-Frank Act will impact virtually every aspect of our financial lives,” says Crouthamel. “The task is enormous, with 145 rules scheduled for adoption in the third and fourth quarters of 2011, plus 30 that are behind schedule.”

Smart Business spoke with Crouthamel about the impact of this legislation on private fund investors and investment advisers.

How will this legislation impact private fund investors?

The Dodd-Frank Act increases the net worth and investments under management requirements for an individual to qualify to invest in private funds. The rules exclude the value of an investor’s primary residence in determining net worth, and this will likely prohibit more investors from investing in private funds. SEC registration is also a significant issue. Many private fund advisers, who were previously not required to register with the SEC, will likely be required to register. This increased oversight may result in additional protections for the private fund investors; however, these protections will not be free. Private fund advisers are going to incur significantly more administrative costs in complying with the SEC requirements, and some of those costs may be passed along to investors.

What effect does the legislation have on SEC oversight of investment advisers?

The debate continues as to who should have regulatory oversight over registered investment advisers. The SEC is overburdened and the number of exams that it can complete is relatively small in relation to the number of advisers. As such, advisers with assets under management of $100 million or less are required to deregister with the SEC and to register with their state agencies.

The Dodd-Frank Act called for a study on enhancing adviser examinations. In January 2011, the SEC’s Division of Investment Management reported the results of its analysis and recommended that Congress consider one, or a combination of, three approaches to strengthen the SEC investment advisers’ examination program. First, it suggests authorizing the SEC to impose user fees on SEC-registered advisers to fund examinations. Second, it proposes authorizing one or more Self-Regulating Organizations to examine SEC-registered advisers. Finally, it recommends authorizing the Financial Industry Regulatory Authority to examine dual registrants for compliance under the Advisers Act. This could result in a political battle between the rules-based system by which broker/dealers are governed and the principles-based system governing registered advisers.

How does the Dodd-Frank legislation impact public company compensation disclosures?

In January 2011, the SEC adopted rules regarding shareholder approval of executive compensation and golden parachute compensation agreements. New rules also require additional disclosure and voting regarding golden parachute compensation agreements with certain executive officers in connection with merger transactions. All of these required votes under the new rules are nonbinding; differences between investors’ recommendations and actions taken by boards of directors could embarrass a company and lead to directors not being re-elected.

Finally, the proposed rules include provisions that require institutional advisers to report their say on pay votes. This provision has not yet been adopted, but it will certainly increase advisers’ administrative costs.

What widespread financial reform is also included in this legislation?

The Dodd-Frank Act extends to credit rating agencies, which were at the center of the recent financial crisis. As a result, Dodd-Frank includes provisions designed to improve the integrity of these credit ratings, including requiring many of the agencies to submit an annual report regarding their internal controls governing the implementation and adherence to procedures and methodologies for determining credit ratings.

There are also new whistleblower rules that provide increased incentives to individuals who voluntarily provide the SEC with original information about a securities law violation, which leads to successful enforcement by the SEC, with sanctions of greater than $1 million.

What can be expected going forward?

Because so much of the Dodd-Frank Act has not been finalized, it is difficult to determine what all of the final regulations will look like. For investment advisers, the challenge will be to stay current with new regulations and to ensure the firm’s policies and procedures reflect the new regulations. For investors, the challenge will be to decipher additional reporting requirements and follow who will ultimately be responsible for oversight of the investors’ advisers. Keeping a watchful eye over the coming months will be critical for advisers and investors alike to ensure they understand the latest developments and how they will be affected.

Todd Crouthamel is a director,  Audit & Accounting, and a member of the Investment Industry group at Kreischer Miller. Reach him at tcrouthamel@kmco.com or (215) 441-4600.

Published in Philadelphia

As the supply chain evolves in today’s demand-driven environment, where end users “want it yesterday,” all players in the chain must collaborate to meet customer expectations. Businesses must foster relationships to thrive by listening to what customers value, understanding common goals and designing mutually agreed-upon expectations.

The lesson that all companies can learn from today’s changing supply chain is that despite technology, nothing beats knowing the customer, says Robert S. Olszewski, director-in-charge of the distribution industry group at Kreischer Miller, a certified public accounting firm located in Horsham, Pa.

“There is an art to supply chain management; painting a picture that connects a network of interrelated businesses to provide products or services required by the customer,” says Olszewski. “Customers need to know that the suppliers of their products or services have their best interests at heart; that’s a tremendous value to end users. A successful business must have personal relationships to garner an understanding of its customers.”

Smart Business spoke with Olszewski about supply chain trends and how these changes will affect manufacturers, suppliers, distributors and end users.

What are the key trends in supply chain management?

Overall, supply chains have become more agile in response to the risks associated with lengthy and slow-moving logistics pipelines. Businesses are forced to continually review how their supply chains are structured and managed. Several factors within the United States have caused companies to seek alternatives as a result of pressures to squeeze additional costs out of operations. Businesses are looking beyond U.S. borders to find more cost-efficient opportunities to manufacture or obtain products.

Second, significant changes in communication are driving change in the supply chain and will continue to do so as technology advances. No one can predict where communications technology will lead the supply chain in the future; we only know that it will continue to make the supply chain operate faster and more efficiently.

Third, there is an emphasis on diversification in the supply chain given recent natural disasters and political turmoil that have had a serious impact on the way products get from a manufacturer to a distributor and, finally, to the end user. Similar to the concept of diversifying investment options, we are seeing an emphasis on ‘source’ diversification.

Finally, collaboration is increasingly important as businesses work to source products from manufacturers and deliver them to customers in the most efficient, cost-effective manner.

How is globalization changing the way products travel from their source to U.S. companies?

Businesses in the supply chain recognize that order fulfillment and delivery times are essential. To that end, businesses that import products are looking beyond traditionally busy international ports, such as those in California, and exploring other alternatives.

Understanding the options may provide some security in unforeseen circumstances and provide more flexibility in accessing imported goods faster. Of course, this can come at a cost, but the ability to get products faster in today’s dynamic supply chain is a priority for some companies.

How are distributors in the supply chain differentiating themselves in a market that is driven by cost-savings and squeezing out the middle-man?

Distributors play a critical role in the supply chain as the coordinator of logistics. They are the ones who comprehend customer demands and ensure that efficiencies are realized, schedules are met and cost savings are gained. In markets where goods are becoming commoditized, distributors recognize that they must do more. They often play a valuable role in our dynamic supply chain as educators, industry experts and consumer advocates.

The concept of providing value and being more than just another link in the supply chain to customers applies to all industries and markets.

Successful businesses realize that it’s not necessarily about the products and services they sell; it’s how they service and partner with their customer base.

What obstacles and opportunities does the supply chain face?

The challenge for distributors in the supply chain comes with customers looking to purchase direct from the manufacturer. Over the years, drop shipments have become more prevalent to meet customers’ expectations for fast delivery. While it would seem that drop shipment cuts out the distributor, this is not the case. In fact, the distributor still serves as the logistics coordinator without having the cost burden of carrying inventory and storing it. Today, distributors are fine-tuning their operations to expedite orders as efficiently as possible to meet demands.

As the supply chain becomes increasingly complex with globalization, technology and customer demands, successful businesses are acutely aware of the need to adapt and evolve with the times to meet customers’ needs in more ways than ever before.

Robert S. Olszewski is director-in-charge of the distribution industry group, at Kreischer Miller in Horsham, Pa. Reach him at (215) 441-4600 or rolszewski@kmco.com.

Published in Philadelphia

As businesses continue to evolve, innovation and creating a culture of change are critical to growing a profitable organization. The companies that are succeeding are the ones that are taking a good look at themselves and considering ways to work smarter, improve efficiencies and, as a result, drive profits.

“It certainly is a new world,” says Stephen Christian, managing director at Kreischer Miller, Horsham, Pa. “Customers’ needs and demands have changed, and employees’ needs and demands have changed, as well. Companies must adapt in response to these changes. But that does not mean you disregard all the good things that got you to where you are today. Instead, by innovating and adapting you can strengthen your organization and look at the challenges as an opportunity to move forward. Without change there is no progress.”

Smart Business spoke with Christian about how to implement changes in an organization to create value.

How can innovation and change lead to opportunities?

Businesses cannot keep operating the same way given the impact of changing times. You can define success in many ways, but one way to define it is financially, by selling more or improving efficiencies to drive down costs.

Regardless of your industry, examine your product portfolio for new opportunities. Can you sell your existing products to different customers, or develop new products to provide more value and options to current customers? Can you enhance product differentiation by adding more pre- or post-sales services?

You should consider process changes, additional automation, investing in technology, improving inventory controls and re-evaluating manufacturing processes to increase efficiencies and gain economies of scale. You should also evaluate your compensation system. Is compensation aligned with performance and desired results? Should more of the compensation be variable in nature?

The list goes on — everything is on the table. Your goal is to challenge the status quo. Ask yourself why you do things the way you do. Is there a better way to do them?

How can an organization decide where to focus its time?

The questions most executives ask are, ‘Where do I start? What areas do I focus on, and what changes will make the most positive impact on my bottom line?’

The first step is to determine your critical success factors. What makes your company tick? How can you make more money?

Focus on the controllable. Talk to customers candidly to gain their insight during this period of self-evaluation. Find out why your customers buy so you can anticipate their needs and adapt to meet them.

Remember, your employees are the ones doing the work. Your salespeople, your workers who produce products and your customer service personnel are the people on the front lines and behind the scenes who keep your company running and who will ultimately implement change. So involve them in the discussion and ask them where opportunities lie.

Also, network with other business owners and take advantage of trade organizations to get ideas from peers. You’ll find that identifying opportunities to innovate is the easy part. It’s implementing change that is tough.

What barriers get in the way of change?

Often, inertia — a lack of momentum, or not having any real action plan to move a change strategy forward — is a barrier to change. Another is not listening to customers and employees.

You might think that business is great now, so there is no reason to change. Short-term, immediate successes can get in the way of achieving long-term goals.  Fear of the unknown is an obstacle. We all like certainty; it’s comfortable to do things ‘just like always.’ But that attitude will cause a business to become stagnant.

And simply treading water instead of advancing forward is a sure killer in this economy.

How can management put a business in the best position to embrace change?

It’s important to make the case for change. The days of dictating and legislating change are over. Explain why change needs to happen and why you are evaluating something new.

Obtain buy-in from key stakeholders and make it clear that once a path is selected, everyone must be on board. Emphasize that change is a team effort and a team process. It’s not going to happen overnight.

Encourage risk-taking and be willing to make adjustments on the fly as you head down the path of change. Acknowledge when you make mistakes and ask stakeholders for ways to improve. Constantly measure your progress and celebrate successes along the way.

Organizations that embrace innovation and change and are willing to adapt will succeed in rapidly evolving times. Acknowledge that change is difficult, commit to innovate to enhance opportunities and have the courage and confidence to follow a plan to accomplish your goals, and growth and profits will come your way.

Stephen Christian is managing director of Kreischer Miller, Horsham, Pa. Reach him at (215) 441-4600 or SChristian@kmco.com.

Published in Philadelphia

Cloud computing can help businesses harness the portability and convenience of Web-based IT services, and if your company hasn’t started investigating this new technology, now is a good time to start.

Cloud computing provides businesses with ease of maintenance, scalability and cost reduction, says Sassan Hejazi, director of the Technology Solutions group at Kreischer Miller, located in Horsham, Pa. Specifically for accounting and financial departments, offsite management of these systems can be particularly valuable from a security and updating standpoint.

Meanwhile, more businesses are looking to the cloud for services instead of purchasing software or overseeing systems in-house that can instead be managed off-site by specialists. Rather than dealing with the limitations of traditional in-house software, companies can simply turn to the cloud and access the programs they need from anywhere.

“Like a utility, when you plug an appliance into an outlet, you get power,” says Hejazi. “You don’t know where that power comes from or who manages the production of that power; all you know is that the power is there when you need it. The IT world is evolving into a utility-based commodity that is very sophisticated and being delivered by specialists. We are now increasingly accessing the technology via ‘the cloud.’”

Smart Business spoke with Hejazi about how businesses can use cloud computing in finance/accounting and other disciplines to streamline their IT portfolios.

What is cloud computing, and how can it work for businesses?

Cloud computing refers to using Web-based applications and services provided by offsite providers. A simple example is e-mail such as Gmail or Hotmail. You can access these services from anywhere with an Internet connection, and you never have to worry about upgrading the program or running out of storage.

Today, most software and hardware providers also offer a ‘cloud strategy,’ so businesses can shift systems they currently manage in house to the cloud and save time, money and resources.

Essentially, cloud computing is the next phase of the Internet evolution. Rather than the Internet serving as a tool for communication, it also can house the systems and services you use to conduct business so you can access these applications anywhere.

What advantages does cloud computing bring to financial and accounting departments?

When finance and accounting departments manage their systems internally, they are responsible for upgrading these systems regularly and keeping up with software changes so they can run them efficiently. The resources required to keep these systems operating at peak performance can be draining, and there’s no reason to expend resources this way now that there are off-site, Internet-based options.

A growing number of applications from leading companies offer cloud-based versions of their accounting and financial systems, which allow businesses to leverage capacity without having to invest in internal resources for basic system maintenance. Cloud-based systems give companies economies of scale because the provider serves many different companies. As a result, resources are highly productive, trained and specialized, giving companies better ROI than if they operated their own system in-house. Essentially, cloud computing allows companies to shift from an internal to an external service provider.

Another advantage is that cloud-based systems are scalable. Companies can easily add more users to increase capabilities, or decrease users to scale back. Also, cloud computing allows companies with multiple locations to access information. Employees can work from home offices or on the road and use the system, as long as there is an Internet connection.

Is cloud computing secure?

There is always some level of risk involved because if a company loses its Internet connection, it cannot access its cloud-based systems. However, this is becoming less of an issue with the newer wireless devices. With a cloud-based system, you also have the ability to access information from anywhere should internal issues such as a system crash occur.

Regarding security, the providers of these offsite systems must earn a SAS 70 certification, which involves rigorous security audits. Generally, they have better backups and disaster recovery than most companies that manage systems internally.

Rest assured, cloud computing has evolved significantly in recent years to become a strong option for companies of all sizes. Of course, to minimize risk, management teams should conduct a thorough study of alternatives and create a cloud computing roadmap.

What should a company consider when evaluating which IT services can be shifted ‘to the cloud’?

First, take an inventory of all hardware and software systems — your portfolio of IT assets. Divide that portfolio into distinct groups, for example, by department and by function, and analyze each section.

How old is the technology? How well supported are the systems? How could operations be improved? Tie this into the bigger picture of business objectives: How does existing software/hardware support your goals for the future? This exercise will help you focus on cloud computing as a business value proposition. As you do this analysis, consider the cost of purchasing systems. It’s not just what you pay today for software/hardware. Figure the total cost of ownership, including periodic upgrades and maintenance.

This is where cloud computing offers a real economic advantage. For scalability, ease of maintenance and lower cost of ownership, cloud computing offers competitive systems that give companies increased flexibility and the ability to access information from anywhere.

Sassan Hejazi is director of the Technology Solutions group at Kreischer Miller, Horsham, Pa. Reach him at (215) 441-4600 or shejazi@kmco.com.

Published in Philadelphia

The 2010 Tax Relief Act has resulted in significant changes to the estate and gift tax rules, providing some clarity — at least for the next two years.

The act provides planning opportunities not only for the living but also for those who died in 2010, as the law is also applied retroactively. However, executors have been provided with a special savings choice and can opt out of the new rules.

The passage of the act also provides a good opportunity to review your will.

Smart Business spoke with Richard J. Nelson, the director of the Tax Strategies Group at Kreischer Miller, about the 2010 Tax Relief Act and what it may mean for you.

What are some of the important provisions of the Tax Relief Act?

For 2011 and 2012, the estate tax exemption will be $5 million and the maximum tax rate will be 35 percent. This is a significant increase in the exemption, which was scheduled to be $1 million in 2011, and a significant decrease in the tax rate, which was scheduled to be 55 percent. The $5 million exemption is per person, so for a married couple, this could mean a $10 million exemption.

The new law also provides a portability feature of the exemption amounts for married couples. Unlike prior law, any exemption that remains unused at the death of a spouse after Dec. 31, 2010, and before Jan. 1, 2013, is available for use by the surviving spouse in addition to his or her own $5 million.

For example, say a husband dies in 2011 with an estate of $2 million. The husband’s estate elects to permit the wife to use her husband’s unused exemption of $3 million. Assuming she has not made any prior taxable gifts, the wife has an available exemption of $8 million upon her death.

Because the new rules are only in effect for two years, both spouses would have to die prior to Jan. 1, 2013, to have this advantage apply. In the event that the wife remarries and the second spouse dies, the exemption would be $5 million plus the unused exemption of the second spouse.

Many wills are written with an allocation to a credit shelter trust, which is formed with the assets of an individual’s estate to take advantage of the exemption amounts. Assets placed in this trust, as well as any appreciation, are generally not subject to estate tax upon the death of the second spouse. During the surviving spouse’s lifetime, he or she is entitled to the income of the trust but is limited in how much of the principal that can be taken out of the trust without the permission of the trustee. For a decedent with an estate value of less than $5 million and a surviving spouse with limited assets of their own, a credit shelter trust may restrict the surviving spouse’s use of these assets.

With the new portability rules, a credit shelter trust may no longer be necessary.

What is the current situation with respect to the estate tax and gift tax exemptions?

The new law reunified the estate and gift tax exemptions at $5 million. Many people have previously taken advantage of the $1 million gift tax exemption. They now have an additional $4 million exemption available to them. Generally, you would consider gifting property that you believe will appreciate in value. Gifting takes the current value of that asset and the future appreciation out of your estate.

The annual gift tax exclusion remains unchanged at $13,000 per donee.

The generation-skipping tax (GST) has also been changed. The GST is an additional tax on gifts and bequests to grandchildren while their parents are alive. The exemption amount has been increased to $5 million and the tax rate reduced to 35 percent.

Do executors have flexibility in applying the rules for 2010 decedents?

Technically, the estate tax expired at the end of 2009, leaving 2010 with no estate tax. The new law revised and retroactively reinstated the estate tax to decedents who died in 2010. This leaves executors of decedents who died in 2010 a choice. The executor can either apply the new rules ($5 million exemption, tax rate of 35 percent on the excess and a step-up in basis to the heirs) or elect out of the new rules (no estate tax and the heirs inherit the property at modified carryover basis).

The new rules provide for a step-up in basis. This means that the basis of the assets the heirs receive will be the fair market value of the assets on the date of death or the alternative valuation date, which is six months later. If the executor elects out of the estate tax, the modified carryover basis rules apply, which generally means that the basis of the assets is the lower of the fair market value on the date of death or the adjusted basis of the property immediately before the death, plus an additional $1.3 million, which is allocated among the assets.

An additional increase of $3 million is allowed for a surviving spouse, for a total of $4.3 million.

The executor should choose whichever method will produce the lowest combined estate and income taxes for the estate and its beneficiaries. Generally speaking, it makes sense to apply the new rules to estates under $5 million.

For estates greater than $5 million, the executor should calculate the estate and income tax consequences under both methods to determine which is more advantageous.

Estate planning is something that everyone should consider. Even if your total estate is less than $5 million, it is important that you have properly drafted wills to take advantage of tax planning opportunities available to you and ensure that your intentions and wishes are carried out.

If you already have a will, now is the perfect opportunity to have it reviewed and updated.

Richard J. Nelson is the director of Kreischer Miller’s Tax Strategies Group. Reach him at (215) 441-4600 or rnelson@kmco.com.

Published in Philadelphia

As we enter the second month of 2011, it’s time to think of some of the resolutions made just a short time ago. For some, it was to lose weight, eat better and exercise more frequently; for others, it was to save more and invest wisely.

As more and more people are increasingly concerned about the viability of our nation’s Social Security system, the focus has continued to shift toward providing for our own retirement, says Mark G. Metzler, director, Audit & Accounting, at Kreischer Miller.

“One mechanism that owners of businesses and their employees often have is their company’s 401(k) retirement plan,” says Metzler. “Because many people are not professional investment managers, an option provided in many plans is ‘target date retirement funds,’ sometimes referred to as ‘target date funds’ or ‘lifecycle funds.’”

Smart Business spoke with Metzler about target date funds and how they can work for you.

What are target date funds?

Target date funds, which have grown in popularity in recent years, are long-term investments, typically mutual funds that hold a mix of stocks, bonds and other investments designed to reduce overall risk. The funds are generally structured as investments for individuals with particular retirement dates in mind. The name of the fund often refers to its target retirement date (e.g., Retirement Fund 2025). As a fund gets closer to its named target date, the investment mix shifts to become more conservative.

This is appropriate because an individual nearing retirement may wish to have his or her investments become more liquid to provide for living expenses, as well as to minimize losses in a volatile market. Ideally, the target date retirement fund concept is a simple way to provide for professional portfolio management. The investment firms sponsoring the funds make the investment allocation decisions for participants based upon the target date.

Are all types of target date funds basically alike?

No. Funds that share the same target date may have significantly different investment strategies and risk profiles. The Department of Labor’s Employee Benefits Security Administration (EBSA) and the Securities and Exchange Commission (SEC) published an investor bulletin stressing that ‘participants should not rely on the fund’s target date as the sole criterion for selecting the investment because funds with the exact same target date may have entirely different risk strategies, risks, returns and fees.’

One of the most significant differences among target date funds is the construction of the ‘glide path.’ The glide path represents the asset allocation philosophy among equities, bonds, cash and other investments at various times throughout the investment life of a participant. Typically, all target date funds have a higher exposure to equities when the participant is furthest from retirement (at the beginning of the glide path) and steadily decrease the exposure to equities as the individual approaches retirement age.

However, different investment managers may have significantly different strategies for a similar target date fund.

The EBSA and SEC provided an example in their bulletin of the extreme differences between target funds with identical target dates. In the example, at its target date, Fund A had an asset allocation of 60 percent stocks and 40 percent bonds, while Fund B maintained an allocation of 25 percent stocks, 65 percent bonds and 10 percent cash investments.

Fund A does not reach its most conservative mix of 30 percent stocks and 70 percent bonds until 25 years after its target date.

How can funds with the same target date have such significantly different investment philosophies?

In the simplest terms, it depends upon whether the fund manager is investing ‘to retirement’ or ‘through retirement.’ When the fund manager invests ‘to retirement,’ it is anticipated that a significant portion of the portfolio will be liquidated at the target date to provide for living expenses, so therefore it would comprise a much smaller percentage of equities. Conversely, when a fund manager invests ‘through retirement,’ it is anticipated that the individual will continue to have a much higher exposure to equities and will continue to invest in the market throughout his or her retirement years.

In the 2008/2009 market downturn, participants close to retirement whose target date funds followed the ‘through retirement’ date philosophy were shocked at the large losses their funds suffered as they mistakenly believed they had been shielded from substantial loss by investing in a target date fund.

What should someone consider when evaluating a target date fund?

First, remember that all investments have some level of risk, and even the same type of investment may have more or less risk than other seemingly identical ones. Participants should read the fund’s prospectus to focus on:

  • When does the most conservative mix of investments occur?
  • What is the fund’s risk level?
  • How has the fund performed in the past, and what is the fund’s Morningstar ranking?
  • How does the asset allocation change over the life of the fund?
  • What fees apply?

Target date funds provide simplification to the average investor. While there is no magic pill that provides for a guaranteed return or that eliminates the risk of loss, target date funds do provide a level of portfolio management and complexity that is typically out of reach for most investors.

Mark G. Metzler is director, Audit & Accounting, at Kreischer Miller. Reach him at (215) 441-4600 or mmetzler@kmco.com.

Published in Philadelphia
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