As the popularity of target date funds has grown over the past five years, so too has the publicity around the differences among the managers and the wide variations in performance and risk exposure that can result.
The lack of a consistent approach among managers also makes it difficult for plan sponsors — or advisers working on their behalf — to evaluate target date providers, leaving many wondering how best to select a target date suite that meets the unique needs and characteristics of their participant base.
For plans looking for an off-the-shelf target date product suited to their participants, the due-diligence process must go beyond traditional performance-based measures such as relative benchmark performance and peer group rankings to incorporate a thorough analysis of the differences in product design and features.
To help plan sponsors in this endeavor, ING Investment Management and the ING Retirement Research Institute recently conducted a survey of plan participants designed to provide insight into participants' perceptions and preferences around target date funds.
Based on this research, there are three key factors that plan sponsors should consider when comparing and contrasting target date offerings:
Glide path construction. The target date design element that arguably has the most significant impact on retirement outcomes is glide path construction — the methodology used to determine how a portfolio's asset allocation is adjusted over time.
Managers take different app-roaches to glide path construction. While some seek to maximize wealth accumulation across the life cycle, others look to limit downside risk near retirement or to provide steady retirement income.
Plan sponsors should understand the glide path philosophy of each potential manager and whether it is aligned with their average participant's retirement income needs, actual behaviors, risk tolerance, sophistication and salary, as well as whether they have other sources of retirement income.
Approach to retirement date. Not only are the years immediately preceding and into retirement when target date equity allocations vary the most, they are also when the emotional and financial impact of a loss can be the most profound.
As a result of the equity market sell-off in 2008, for example, losses among target date funds with a 2010 retirement date ranged from 4% to 41%. Many participants were shocked by the magnitude of their losses — and their equity exposure — so close to retirement.
In our participant survey, we found that 80% of target date users and 66% of non-users preferred a retirement plan that provides greater protection against investment losses near and in retirement, versus one that provides greater investment growth.
Diversification. Sponsors should consider whether a target date suite provides participants with a level of diversification — in terms of asset classes and investment managers — consistent with what is available to them within the existing defined-contribution investment menu.
Given that the majority of target date fund investors concentrate 100% of their defined-contribution assets in these funds, their diversification in many cases will depend solely on the fund's structure.
While DC plans typically employ an “open architecture” approach that includes managers from multiple fund families, most target date funds feature “closed architecture,” meaning that they use only managers within their fund family.
Meanwhile, the breadth of a target date fund's underlying asset classes can vary significantly, with some managers employing only traditional asset classes, while others include alternative investments.
Participants in our survey indicated a strong preference for both manager and asset class diversification; 84% of target date users prefer a multimanager approach, and 89% expressed an interest in target date funds that incorporate a broad range of asset classes.
Given all the variables involved with the management of target date funds, it is clear that traditional measures of evaluating investment managers are not sufficient. In addition to an assessment of the different product designs offered by various target date fund managers, a deeper understanding of participant risk tolerances, preferences and expectations can help plan sponsors choose a manager that best meets the needs of their participants.
Paul Zemsky is the chief investment officer for multiasset strategies, and Susan Viston senior portfolio specialist, at ING Investment Management U.S.
