TARGET DATE. EVALUATION Top advisors share experiences and insights on the use of target date funds

Transcription

1 TARGET DATE EVALUATION Top advisors share experiences and insights on the use of target date funds

2 What are some of the factors that influence decision makers choices about target date funds (TDFs)? Is the main focus still on things such as performance and expenses? Or are other critical elements, such as a fund s glide path and asset allocation, now getting the attention they deserve? Journey spoke recently to three veteran retirement plan advisors about the kinds of conversations they re currently having with plan sponsors about TDFs, and how the decisions plan sponsors make relating to these popular funds can significantly impact the ability of plan participants to reach their retirement goals. Roundtable panelists were Troy Hammond, President and Chief Executive Officer of Pensionmark Retirement Group, a retirement plan consulting firm based in Santa Barbara, California; Chad J. Larsen, President of Moreton Retirement Partners, a retirement plan consulting firm based in Denver, Colorado; and Mike Sanders, a Principal of Cammack Retirement Group, a retirement services firm based in Boston, Massachusetts. JOURNEY: How has your clients approach to TDF selection and evaluation changed since interest in these funds exploded following the introduction of the Pension Protection Act of 2006? And how has this affected the types of discussions you re having with clients about these strategies? HAMMOND: We ve definitely seen a shift in perspective over the past few years. It wasn t too long ago that many plan sponsors would simply ask us to run analytical reports on fund performance and costs. Now, we re having discussions about much broader issues, such as the funds glide paths, the demographics of the plan and whether the funds should be managed to or through retirement. Most importantly, we re talking more about the appropriateness of various options and how they can be used to help meet participant needs. LARSEN: The Pension Protection Act of 2006 has definitely taken our conversations with plan sponsors to a whole new level. So, too, has new guidance issued last year by the Department of Labor (DOL) to help plan fiduciaries select TDFs. As Troy said, we re now putting more effort and energy into helping plan sponsors understand the processes for portfolio construction and risk management and getting them more comfortable with the choices that make the most sense for their employees. SANDERS: Since all of our clients already have TDFs in place, most of our conversations are around helping plan sponsors understand exactly why they are already using a particular TDF. We help them peel back the onion on factors such as participant behavior, employee demographics and average worker tenure, and discuss important components of their retirement plan, such as whether they also have a defined benefit plan or whether they match employee contributions. JOURNEY: One part of the DOL s guidance was the suggestion that plans that offer proprietary or prepackaged TDFs also consider custom or non-proprietary options. How are you approaching these kinds of conversations with clients?

3 MEET THE PANELISTS Troy Hammond is President and Chief Executive Officer of Pensionmark Retirement Group, a retirement plan consulting firm based in Santa Barbara, California. Founded in 1988, the company, with 30 locations, is recognized as one of the leading retirement plan consultants in the nation, advising on more than 1,200 retirement plans with roughly $8 billion in assets. Chad J. Larsen is President of Moreton Retirement Partners, a comprehensive investment and retirement plan consulting firm based in Denver, Colorado. With more than $2 billion in retirement plan assets under advisement, the company serves corporations, and government and nonprofit organizations throughout the United States. Mike Sanders is a Principal of Cammack Retirement Group, a retirement services firm based in Boston, Massachusetts. Founded in 1958 as Cammack LaRhette, the firm is a recognized leader in retirement planning, execution and strategic management. It provides investment advisory, consulting and compliance services to programs with assets of more than $43 billion. SANDERS: A good majority of our business is 403(b), so we have to use an off-theshelf product, such as a mutual fund or variable annuity. For our other clients, the decision usually comes down to two things: the size of the plan and the plan sponsor s comfort level with various options. By first looking at things such as demographics, we can isolate different types of glide paths that may be right for a plan. This can help simplify decision making because we can perform a cost/benefit analysis of what the plan sponsor would need to spend to build a custom solution versus what may already be available with a preexisting, decently priced share class having a similar glide path. LARSEN: For most risk/reward profiles and investor tolerances, there s usually something off-the-shelf that can address a plan s needs. That said, I think we sometimes err on the side of using prepackaged TDFs. Given the number and variety of funds, we don t do a lot of modeling. And for many of the plans for which we do model, we usually end up with a stripped-down version of what s available from an asset class perspective, especially if the plan is limited to funds in its core menu. JOURNEY: Are there enough solutions in the market that you can use to align to the specific needs of your clients? HAMMOND: If you re working with plans of, say, less than $100 million in assets, you traditionally have been limited to off-the-shelf solutions. The analysis starts by first narrowing the field of opportunities by defining the appropriateness of different funds to the demographics of the client. So, instead of looking at 50 TDFs, you re now looking at only, say, five or six options that offer the kind of glide path and asset allocation that may meet the needs of the plan participants. The real challenge is how do you take that conversation to the next level of customization, which is typically reserved for the institutional market? Based on our experiences of the past 25 years, we know that what happens in the institutional market eventually trickles down to smaller plans. I do believe we ll all be in a better place when we re able to offer customized solutions to plans of all sizes and have conversations with our clients regarding the ability to customize glide paths down to the participant level. JOURNEY: What types of discussions are you having with plan sponsors about active versus passive TDFs? Are your clients interested in different philosophies and approaches, or are they mainly just concerned with fees? HAMMOND: Our conversations generally vary depending on who brings up the subject. If we start the dialogue, we re going to talk about how we can offer active and passive strategies, as well as a blend of the two. We ll also discuss the differences among the various options, as well as how certain things, such as the demographics of the plan, may affect the option the client chooses. If one of our clients begins the conversation, however, it s usually about fees. That s because there s a lot of pressure on plan sponsors today to get fees as low as is reasonably possible. Fortunately, I think all of the focus on fees over the last few years has only served to strengthen our role as advisors. As plan sponsors face greater scrutiny on fees, they are increasingly looking to their advisors to help protect them from any potential liabilities. LARSEN: For us, one of the most important discussions we re having with plan sponsors is helping them understand that, even with a passive strategy, the decisions a portfolio manager makes about the glide path will have the biggest impact over the long term on participants. So, even if plan sponsors say they believe in passive management, they still need to understand that there are active decisions being made. JOURNEY: Are you saying there s really no such thing as a passive target date strategy? SANDERS: Yes, that s right. When it comes to an investment strategy such as large cap, you can always have a philosophical debate about why someone might want to

4 invest in the index rather than use an actively managed fund. But it s a different story with target date strategies. There are index-based target date strategies, but they re not passive strategies because the managers are making active decisions. JOURNEY: How do you evaluate alpha in TDFs? What s more important, the overall performance of the underlying managers, the glide path or the tactical decisions of the portfolio manager? And how heavily do you weigh each of these factors in recommending a fund or funds? LARSEN: That s a tough question. I generally look at it through the lens of risk management and how well a fund performs in adverse market conditions. That way, it becomes a question of risk-adjusted returns, as well as how a fund or series of funds responds in times of market stress. Even though you want the underlying managers to generate alpha, you need to take into account the entire package and how things percolate up in terms of managing risks for the fund in general. Whether you re doing this tactically as part of the glide path or through the underlying fund managers, I want to know you have the ability to manage risk at every point along the entire process. We can t lose sight of the fact that much of the scrutiny that target date strategies are facing right now stems from adverse conditions in We need to spend a lot of our time understanding the risk management process of the various options available to our clients. At the same time, I think this type of focus and scrutiny can be a double-edged sword. It s good because it helps protect the interests of the growing number of participants who invest in TDFs through programs such as auto enrollment and auto escalation. The danger, however, is that we take something that s working really well, and that was originally designed to simplify investment decisions for participants, and make it too complex or difficult to understand. It ll be interesting to see what the DOL recommends in the way of additional disclosures. HAMMOND: Honestly, I don t think we have enough data to know the right answer to that question. Personally, I ve always been a fan of active management, but alpha doesn t necessarily need to be measured in terms of increased returns. As my colleagues have said, it can come from other things, such as mitigating risk. Frankly, 2008 was a really frustrating year for me because I thought TDFs got a bad rap, even though, in terms of outflows, most of the participants who were invested in TDFs actually stayed put. The percentage of doit-yourselfers who moved their assets to cash was exponentially higher than the percentage of those who stuck by their professionally managed TDFs. And, if you look at the data, you ll see that the people in TDFs won. Even if they were in a bad TDF, they did better than the average investor who was making his or her own decisions. And that s because the TDF investor didn t cash out and end up missing out later on the up market. So, while I was frustrated by the way the industry handled the TDF debacle of 2008, there were certain benefits that resulted from this experience, such as helping to raise awareness among advisors like us that we need to spend more time helping plan sponsors understand what they own. In an ideal world, I d want a fund that is a blend of active and passive, at least on the level of the sub-accounts. It should be something that uses low-cost indexes in certain asset classes where it s harder to add alpha, but is also actively managed in those asset classes where it s generally easier to add alpha. In that way, you ll end up with a nice midway point be- ONE OF THE MOST IMPORTANT DISCUSSIONS WE RE HAVING WITH PLAN SPONSORS IS HELPING THEM UNDERSTAND THAT, EVEN WITH A PASSIVE STRATEGY, THE DECISIONS A PORTFOLIO MANAGER MAKES ABOUT THE GLIDE PATH WILL HAVE THE BIGGEST IMPACT OVER THE LONG TERM ON PARTICIPANTS. Chad J. Larsen President of Moreton Retirement Partners

5 THERE ARE INDEX-BASED TARGET DATE STRATEGIES, BUT THEY RE NOT PASSIVE STRATEGIES BECAUSE THE MANAGERS ARE MAKING ACTIVE DECISIONS. Mike Sanders Principal of Cammack Retirement Group J.P. MORGAN S NEWLY ENHANCED TARGET DATE COMPASS SM PROGRAM IS NOW AVAILABLE Target Date Compass SM enables advisors to help plan sponsors make informed decisions around evaluating and selecting the right TDF for DC plans. The program now includes enhanced functionality, expanded analytics and a more intuitive design. Contact your J.P. Morgan representative to learn more. tween saving money and taking advantage of the value that active managers can add. While I think there will always be a debate over active or passive, I think this argument is different for TDFs than for regular mutual funds because a TDF has two levels of alpha: the glide path and the underlying investments. And I don t know what the answer is. We do, however, believe that the glide path is the more important alpha decision. JOURNEY: Do fiduciary considerations play a role in this evaluation? HAMMOND: Yes. If you re looking at fiduciary risk which is a topic our clients talk about all the time an all-index portfolio may be the best option, even if it s not necessarily the best choice for helping your employees achieve optimal retirement outcomes. By choosing this option, a plan sponsor is giving participants the ability to diversify their investments across a variety of asset classes. Plus, because you re buying the indexes, you re allowing people to invest in inexpensive options. So, there s definitely a very compelling argument for someone acting as a fiduciary to simply pick a low-cost, well-diversified TDF. In addition, there is no need to monitor the riskadjusted alpha that the managers are adding in the underlying portfolio. Passive management can be the path of least resistance. JOURNEY: What are some of the different tools you use when talking about TDFs with plan committees? SANDERS: We use a number of tools those from J.P. Morgan and from other vendors, such as Lipper, as well as our own proprietary tools to analyze things such as a plan s demographics, including the amount of assets invested by different age bands of participants that line up with the five-year increments of TDFs. This helps us determine which groups of employees are saving the most and which are the most likely to work for an organization the longest, so that a plan sponsor can select a fund with the glide path that best meets the needs of plan participants. HAMMOND: In our view, it s difficult to put TDFs on equal footing unless you re doing a lot of your own custom work. So, we ve developed a number of different, customized ways of looking at TDFs that use a variety of tools, such as an off-the-shelf scoring system. In truth, TDFs are probably a good decade behind other investment strategies in terms of automation. As a recovering computer science major, that s something I emphasize as a major part of our business practice: automation and the streamlining of processes. There s a lot of hand-holding and manual work that needs to be done to get the kind of analysis we need to make educated recommendations for our plan sponsors. Eventually, we ll get to where we need to be. But there are so many variables that need to be considered glide paths, portfolio construction, drawdowns, among others that distinguish TDFs from other investment options. For now, we need to use multiple resources to analyze these funds in an appropriate way. And we ll need to keep working like this until our industry gets to the point where it has a better way to put these funds on equal footing. JOURNEY: Despite these challenges, target date strategies have clearly made great strides in recent years. What s your assessment of TDFs today? LARSEN: The growth of TDFs has been one of the most positive changes I ve seen in all my years in this industry. Fifteen or 20 years ago, all we talked about was how to get participants adequately diversified. The introduction of TDFs has made this task so much easier and simpler, and sometimes we lose sight of that. I also think that the long-term value and benefits of TDFs are tremendous. When I look at a particular plan and see that the majority of its existing and new assets are in TDFs, I m grateful that so many participants are investing in diversified strategies. While we re likely to be debating things like the appropriateness of CONTINUED ON PAGE 27

6 YOU CAN ARGUE AROUND THE FRINGES ALL DAY LONG, BUT IF YOU LOOK AT THE RESULTS, TDFs HAVE HAD A DRAMATIC IMPACT ON THE ABILITY OF PEOPLE TO RETIRE WITH DIGNITY. Troy Hammond President and Chief Executive Officer of Pensionmark Retirement Group the glide path or other features for quite some time, we are light-years ahead of what we were dealing with 20 years ago. SANDERS: I firmly believe that TDFs have been an overwhelmingly positive addition to the retirement investing community. Research shows that investors who left their assets in TDFs during the turbulent equity markets of 2008 were more likely to be in a better position than their do-it-yourself counterparts. TDFs are still in their infancy stages and, as time progresses, comfort level and ability to analyze these suites will improve. HAMMOND: Like Chad and Mike, I m a huge proponent of target date strategies. I was also rattling my saber in 2008, defending the fact that these funds had revolutionized participant behavior. And in the five years or so since we ve been aggressively doing things like auto enrollment and auto escalation, the impact has been exponentially better. You can argue around the fringes all day long, but if you look at the results, TDFs have had a dramatic impact on the ability of people to retire with dignity. Yes, we can always get better. Yes, we need to find better ways to analyze TDF data. And, yes, we need to get better at adjusting glide paths. At the end of the day, however, TDFs have revolutionized our business. TARGET DATE FUNDS. Target date funds are funds with the target date being the approximate date when investors plan to start withdrawing their money. Generally, the asset allocation of each fund will change on an annual basis with the asset allocation becoming more conservative as the fund nears the target retirement date. The principal value of the fund(s) is not guaranteed at any time, including at the target date. Certain underlying Funds of the Target Date Funds may have unique risks associated with investments in foreign/emerging market securities and/or fixed income instruments. International investing involves increased risk and volatility due to currency exchange rate changes, political, social or economic instability, and accounting or other financial standards differences. Fixed income securities generally decline in price when interest rates rise. Real estate funds may be subject to a higher degree of market risk because of concentration in a specific industry, sector or geographical sector, including but not limited to, declines in the value of real estate, risk related to general and economic conditions, changes in the value of the underlying property owned by the trust and defaults by the borrower. The fund may invest in futures contracts and other derivatives. This may make the Fund more volatile. The gross expense ratio of the fund includes the estimated fees and expenses of the underlying funds. This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for investment, accounting, legal or tax advice. J.P. Morgan Asset Management is the marketing name for the investment management businesses of JPMorgan Chase & Co. and its affiliates worldwide. Those businesses include, but are not limited to JP Morgan Chase Bank, N.A., J.P. Morgan Investment Management Inc., Security Capital Research and Management Incorporated and J.P. Morgan Alternative Asset Management, Inc. IRS Circular 230 Disclosure: JPMorgan Chase & Co. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with JPMorgan Chase & Co. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.