After being battered by a rough market in 2008, target date funds continued to face the problems of attracting consistent contributions from participants, controlling the amount of pre-retirement distributions and discouraging investors from bailing out after they retire, according to a report from J.P. Morgan Asset Management.
After being battered by a rough market in 2008, target date funds continued to face the problems of attracting consistent contributions from participants, controlling the amount of pre-retirement distributions and discouraging investors from bailing out after they retire, according to a report from J.P. Morgan Asset Management.
“Participants on average are clearly not saving enough for their retirement needs, and our current research shows this may be getting worse for a sizable number of investors,” the report said.
The study analyzed data from 2007 and 2008, building on J.P. Morgan Asset Management research published in 2007 that covered 2001 through 2006.
“The "wow' moment for me” was the new survey's tracking participants over time, Anne Lester, a managing director and co-author of the research, said in an interview.
The research followed people over 65 who stopped working in 2006 and remained invested in their plans. From 100% invested in December 2005, the percentage dropped to 62% the next year, to 33% in December 2007 and to 19% by December 2008.
Even though target date funds, including what Morningstar Inc. calls the “much-maligned” 2010 fund group, made a comeback last year because of a rising stock market, the money manager's findings are powerful reminders that developers of target date funds must be more sensitive to participants' attitudes about investing and saving in an uncertain economy.
Otherwise, participants will be disappointed with these funds, many of which, the report said, “have too much volatility embedded in their portfolio design.”
However, the good news is that the bad news wasn't as bad as J.P. Morgan Asset Management executives had feared.
Several indicators are “marginally worse,” Ms. Lester said. “On the flip side, it didn't get that much worse.”
The first survey was more surprising to Ms. Lester because it showed a big gap between what the report called “simplified industry assumptions” and marketplace reality. The company's J.P. Morgan Retirement Plan Services unit, record keeper to more than 350 defined-contribution plans with 1.7 million participants, provided the raw data about target date funds and other funds for this research.
In the first survey, conventional wisdom about annual salary raises, contribution rates, participant borrowing, premature distributions and post-retirement withdrawals often differed dramatically from what researchers found.
For example, the industry assumption that participants would withdraw a consistent 4% to 5% annually wasn't in the same ballpark as the finding that the average participant withdrew more than 20% a year at or soon after retirement.
The industry assumption that participants don't borrow from their funds clashed with the first survey's finding that 20% of participants borrowed on average 15% of their account balance. The most recent research found that in 2008, 17% of participants borrowed on average 25% of their account balance.
Ms. Lester said that she is concerned that borrowers will stop contributing to their retirement plans while they pay off the loans.
“The most disturbing finding to me was the lower savings rate,” she said. The initial industry assumption was that participant contributions started at 6%, increased steadily and reached 10% of salaries by 35.
The earlier research found that contributions started at 6%, reached 8% by 40 and reached 10% by 55. The most recent research found, however, that the average contribution rate started at 5.7%, rose to 8% of salary by 45 and reached the 10% level at 57.
“These differences may seem insignificant, but they may have sizable compounding effects,” according to the J.P. Morgan Retirement Plan report. “This potentially disturbing trend could force younger investors to play a difficult game of "retirement catch-up' in their 40s and 50s.”
EVERY OTHER YEAR
Among other issues where reality didn't match assumptions about consumer behavior, the latest research found that the average participant received a salary increase every other year — rather than the conventional wisdom of annual raises or the first survey's report of raises every two out of three years.
Given that participants acted differently from how experts had expected, J.P. Morgan Asset Management executives advocate that target date funds broaden their asset classes to include such areas as emerging-markets equity, emerging-markets debt, real estate, real estate investment trusts and high-yield fixed income to reduce expected volatility “without sacrificing long-term potential.”
Such a portfolio is preferable to target date funds that have too big a chunk of equity, especially in the five to 10 years before retirement, according to the report.
“Portfolios that tempered risk purely with more-conservative holdings were less volatile, but they also drastically curtailed long-term return potential,” according to the report. Lower volatility “may help minimize the long-term impact of negative participant behaviors,” such as loans, reduced contributions and withdrawals.
Greater portfolio diversity gets enthusiastic support from Casey Quirk & Associates LLC, a consulting firm for investment management firms.
In conjunction with the Profit Sharing/401k Council of America, the firm published a survey in November saying that even though the average target date fund lost 32% of its value in 2008, nearly 90% of plan sponsor survey respondents were satisfied with their target date offerings “to some degree.” Nearly two-thirds said that they would consider changes to their target date funds.
“They're not going to throw their target date funds over the side,” David J. Bauer, a Casey Quirk partner and survey co-author, said in an interview.
The turmoil surrounding target date funds in 2008 created a greater opportunity for designing plans that are less volatile than what Mr. Bauer calls the “first-generation” funds, especially the 2010 funds whose flaws included participants' assumptions that these funds were low-risk investments and wide variations in the funds' equity exposures.
“There are questions but also key opportunities from a product development perspective,” said Mr. Bauer, who said that target date funds should be broadened to include asset categories such as Treasury inflation-protected securities, commodities and real estate. “Asset managers have to find the right mixes for plan sponsors, and sponsors have to be comfortable.”
The Casey Quirk survey predicted that target date funds will grow to $2.6 trillion in assets by 2018, compared with $311 billion in 2008.
“Target funds are in the spotlight, and when you're in the spotlight, you've got to start dancing,” Mr. Bauer said.
“Performance didn't match expectations for many of the first-generation funds,” he said. “We can do better for the investor the next time.”
Robert Steyer is a reporter at sister publication Pensions & Investments.
