In case you missed it… Investing in your DC Plan: Target Date Funds – Do They Work?


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In case you missed it… Investing in your DC Plan: Target Date Funds – Do They Work?

“In the United States, 66% of Defined Contribution (DC) pension contributions go into target date funds (TDFs) and TDFs have now taken over as receiving the majority of DC contributions from US equity,” stated Sonya Uppal, Vice President of Defined Contribution and Retirement at Franklin Templeton Investments.

Over the past few decades there has been an evolution in the Canadian pension landscape from balanced funds to asset allocation funds to target date funds in the defined contribution space.

TDFs have gained in popularity, especially in the US, and both Uppal and co-presenter Keith Tomchuk, Senior Consultant at Willis Towers Watson agree that not all target date funds are created equal.

Common criticisms of target date funds include lack of flexibility (tactical or dynamic asset allocation), no incorporation of risk tolerance from the member (solely based on retirement age), and single manager solution (one manager is rarely best in each and every asset class).

Uppal suggests that when considering target date funds plan sponsors should ask themselves the following questions:

1) What are the objectives of the target date fund in terms of income adequacy and account balance growth?

2) What does the target date fund glide path look like and is it a) to retirement (i.e. asset mix does not change after retirement) or b) through retirement (one typically continues to have a higher equity content) through retirement?

3) Does your manager incorporate a risk overlay in their target date funds?

4) Are they able to navigate tactically/dynamically depending on market events and environments; or do they rebalance at regular intervals?

Mr. Tomchuk’s presentation focused on selection and monitoring of target date funds. During the selection process it’s important to realize there is a considerable difference between the glide paths and the amount of risky assets (typically equities) at the start and the end of the glide path. Tomchuk also highlighted the differences between “to” and “through” retirement where the de-risking process (of shifting to a more conservative asset mix) in a “to” retirement solution happens before the target date.

In comparing TDFs, Willis Towers Watson considers protection of capital, the expected age that depletion of assets is likely to occur and the probability of outliving the assets. Accumulated balances can vary based on how aggressive the glide path is. Furthermore they analyze the likelihood of 25% loss at different time periods from retirement (e.g., at 10, 5, and 2 years) and results again can differ significantly.

So, how should sponsors decide on TDFs? In addition to glide path considerations Tomchuk highlighted the following:

1) Diversification through a broader range of asset classes  (alternatives such as real estate, infrastructure and alternative credit)

2) Quality and diversity of underlying funds and fund management teams

3) Business situation and circumstances (business structure and stability of support team)

4) Fees

In Willis Towers Watson’s view, past performance should be given less weight in the decision making process.

On monitoring results, Tomchuk stated “we do not believe peer group analysis is particularly useful as there are relatively few competitors.” Generally active managers are expected to add value above a benchmark and passive managers should track benchmarks, and lastly if tactical management is allowed it should also add value over time. Fees are also important in determining whether the interests of the TDF manager and the investors are aligned. Willis Towers Watson’s focus is on returns over the long term for retirees to meet their retirement savings goals.

Both presenters offered some great food for thought to plan sponsors in choosing the right TDFs to include in their pension plan fund choices. 

-          Stian Andersen

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