The more than $700 billion in assets under management in target date mutual funds is proof of the 21-year success story of the vehicles, which provide investors with diversified portfolios set to individual retirement dates.
But success breeds competition, and as the market has grown to 54 separate target-date fund series (from 51 with $600 billion in assets a year ago) that cater to retirement dates as far out as 2050, it's only natural that
performance would start to overshadow risk management.
For younger investors, risk is less of an issue. But some target date fund managers are still dangerously stepping on the gas for those in or nearing retirement.
It might seem counterintuitive, especially considering that the average 401(k)
account has just $91,000, but investors shouldn't be trying to make up for savings shortfalls by getting more aggressive as they get closer to retirement.
In a lot of target date strategies, that is essentially what is happening, although the companies I spoke with claim their strategies are more aggressive for other reasons.
In many respects, it boils down to an almost philosophical approach, along with some assumptions about how long individuals will stay invested in a particular target date fund after they retire.
One school of thought, generally represented by proponents of the more-aggressive portfolios, embraces the so-called “through” glide path that factors in a few decades of income needs in retirement.
According to Morningstar Inc., 32 of the
54 target date series use a “through” glide path strategy. The remaining 22 use a generally more conservative “to” glide path, which assumes that most investors at retirement age will be rolling over their company-sponsored retirement savings accounts, where most target date funds are offered. That rollover assumption reflects the fact that within three years after retirement, 80% of retirees are, in fact, rolling over those assets, often into individual retirement accounts.
That begs the question, then, of why the majority of target date funds use a “through” glide path when they must know most investors are not staying invested very long after they retire.
“We know that investors withdraw a substantial portion of assets when they retire, so we based our glide path on empirical data and on what investors do, rather than what we think they should do,” said Anne Lester, head of the global retirement business at JPMorgan Chase & Co., which uses a “to” glide path.
“To build a product for people who aren't there, I just don't understand,” she added.
What Ms. Lester does understand is the double-edged sword that some of the more aggressive target-date strategies employ.
“I think performance chasing is absolutely a potential issue,” she said. “We think of risk as the risk of a market drawdown, inflation risk, rising interest rates and longevity risk.”
Longevity risk, or the risk of outliving one's assets, is the point that “through” path proponents often tend to lean on to justify riskier allocations even for the most mature target date strategies.
At JPMorgan, for example, Ms. Lester said the 2015 target date strategy will have between 30% and 35% allocated to equities. By comparison, the 2015 target date strategy offered by AllianceBernstein has an equity allocation of 65%.
In January, AllianceBernstein introduced a new multimanager target date series that has a slightly less aggressive 55% allocation to equities for the 2015 portfolio.
“We're clearly known as the high-equity guys, but we don't think we're going to be known for that as much going forward,” said Richard Davies, head of the defined contribution business at AllianceBernstein.
“We are designing these funds as best we can to support a reasonable level of withdrawals for 25 or 30 years of retirement, because longevity risk is one of the risks that retirees face,” he added. “Should we design plans for people trying to do the right thing, or for the people who are going to just spend their money?”
Presented with the possibility that older workers could face another 2008-style market correction, when the S&P 500 Index lost 37%, Mr. Davies challenged retirement plan sponsors to do what's best for employees.
“High-equity glide paths will leave people, on average, with higher account balances at age 65,” he said. “Some sponsors will say they're willing to give up some upside three or four years before retirement to avoid exposing people to another 2008, but the funds that want less equity exposure as investors get closer to retirement are less concerned about keeping investors in their plans after retirement.”
James Lauder, portfolio manager and chief executive of Global Index Advisors Inc., which subadvises the Wells Fargo target date funds, believes it is
less about managing portfolios for retirees than it is about boosting performance numbers to attract the attention of plan sponsors, consultants and financial advisers that manage company retirement accounts.
“We know that, over the long term, the median outcome from being aggressive to conservative is not that much different, but being more conservative limits the downside potential as investors get near retirement,” he said. “If I were a plan sponsor, I would err on the side of being conservative and cater to the most risk-averse and least-sophisticated investor I have.”
If ever there were a case for looking past star ratings based on past performance, it would involve the nearest-maturity target date funds.
Morningstar isn't likely to strip its coveted star ratings from target date funds, but it does offer some forward guidance through its analyst ratings on 24 of the 54 series.
Of those, two are rated gold, five silver, seven bronze, seven neutral and three negative.
It's a good place to start.
