TARGET DATE COMPASS SM EVALUATE AND SELECT TARGET DATE FUNDS WITH GREATER KNOWLEDGE AND CONFIDENCE SM

Transcription

1 TARGET DATE COMPASS SM EVALUATE AND SELECT TARGET DATE FUNDS WITH GREATER KNOWLEDGE AND CONFIDENCE SM

2 Helping plan sponsors navigate an increasingly complex path SELECTING A TARGET DATE FUND CAN BE ONE OF THE MOST IMPORTANT DECISIONS THAT A PLAN SPONSOR WILL MAKE TARGET DATE FUNDS SHARING THE SAME TARGET DATE CAN HAVE DIFFERENT INVESTMENT STRATEGIES, GLIDE PATHS AND INVESTMENT-RELATED FEES ONE-THIRD OF PLAN SPONSORS DO NOT UNDERSTAND HOW THEIR TARGET DATE FUNDS ARE CONSTRUCTED 1 1 J.P. Morgan Plan Sponsor Research 2013

3 TARGET DATE FUNDS ARE THE FASTEST-GROWING INVESTMENT OPTION IN DEFINED CONTRIBUTION PLANS TODAY. Since the Pension Protection Act of 2006 provided plan sponsors with the option to designate a qualified default investment alternative (QDIA), the majority of plan sponsors have chosen a target date fund (TDF) as their QDIA. Today, nearly 70% of net new flows are going into this type of investment. 2 Because selecting a QDIA affects so many plan participants, picking the right one can be one of the most important decisions plan sponsors make. But not all TDFs are created equal. Many TDFs even those sharing the same target date can have different investment strategies, glide paths and investment-related fees. Because these differences can significantly affect a TDF s performance, it is important that plan sponsors understand these differences when selecting this type of investment option. As fiduciaries, plan sponsors have to navigate an increasingly complex universe to select a TDF family that is aligned with their plan s objectives. While the law relieves fiduciaries of liability for the investment performance of accounts of participants who have defaulted into QDIAs, plan sponsors are still responsible for prudently selecting and monitoring the investment option to be used as the QDIA. Many plan sponsors, however, find their TDF s investment strategies and glide paths a challenge to decipher. In fact, our research indicates that many plan sponsors do not understand their TDF s methodology with roughly one-third saying they understand them less than reasonably well. 3 TARGET DATE COMPASS SM HELPS PLAN SPONSORS: Clarify plan goals and identify the behaviors and needs of their participants Map these needs and goals to a particular type of TDF family Assess and compare the differences among the wide range of TDF families, while narrowing down that universe to TDFs more closely aligned with their plan goals and participant needs Establish and document a process for selecting and monitoring a TDF family 2 Callan Investments Institute: DC Observer, Third Quarter J.P. Morgan Plan Sponsor Research

4 Incorporating Target Date Compass SM into a plan s evaluation process THE GROWTH OF TDFS AND INCREASED REGULATORY SCRUTINY AROUND TDF SELECTION HAVE MADE IT MORE IMPORTANT THAN EVER FOR PLAN SPONSORS TO ACT PRUDENTLY IN MAKING AN APPROPRIATE TDF CHOICE. Target Date Compass SM provides plan sponsors with resources to help meet their fiduciary obligations associated with TDF selection by providing them with a framework to evaluate and compare TDFs in a prudent, documented and objective way. Introduced in 2008, Target Date Compass was built on the premise that how a TDF is designed and implemented can significantly affect the funds risk-return profile and potential volatility. As a result, Target Date Compass helps plan sponsors assess the type of fund that is most appropriate for the plan. In general, there are two key factors the TDF s equity exposure at the target date and the level of diversification that can have a significant impact on the TDF s potential volatility and ability to produce investment returns over time. These two factors, which can vary significantly among TDF families, reflect the trade-off between the long-term growth and relative volatility of participants account balances, especially within five to 10 years before or after the target date. Target Date Compass starts with a questionnaire to help plan sponsors understand and consider the characteristics and behaviors of their workforce in order to select an appropriate TDF strategy. The goal of the questions is to assess a plan s desired level of equity exposure at the target date and asset class diversification. Based on the responses, plan sponsors are guided to one of four Target Date Type SM quadrants on the Target Date Compass Quadrant Map, where each fund family is plotted according to its percentage of equity exposure at the target date and the level of asset class diversification across the TDF suite. THE FOLLOWING PAGES OUTLINE THE STEP-BY-STEP PROCESS FOR USING THE TARGET DATE COMPASS PROGRAM. 2

5 STEP 1. ASSESS THE PLAN S DESIRED LEVEL OF EQUITY EXPOSURE FOR PARTICIPANTS AT OR NEAR RETIREMENT In order to determine the desired level of equity exposure for participants at or near retirement, plan sponsors need to gauge their responses to the following three considerations: THE PLAN S GOALS Plan sponsors goals for participants will determine their comfort with the level of equity exposure at the target date, especially during the critical five-year period leading up to and immediately following retirement. If, for example, the objective is to minimize the risk of a dramatic shortfall close to retirement, then lower equity allocations close to the target date may be appropriate. But if maximizing asset growth through retirement is the goal, then higher equity allocations will be needed to generate returns although market volatility may hurt savings balances. PLAN PARTICIPANTS INVESTMENT BEHAVIORS Participants actual saving and investment behavior such as the amount of their contributions, the frequency with which they take loans and the levels of their distributions can have a significant impact on their savings balances. Plan sponsors should consider potential gaps between a plan s basic assumptions and actual behavior patterns since that may impact projected assets available at retirement. THE PLAN S APPROACH TO RISK MANAGEMENT Taking into account their employees demographics and investment experience, plan sponsors need to consider the trade-off between seeking upside growth potential and minimizing downside risk. IMPLICATIONS: The answers to three key questions relating to these considerations will yield an equity exposure score that determines whether plan sponsors should favor TDFs that hold less equity at the target date as a way to minimize volatility versus holding more equities as a way to maximize account balances throughout participants lifetimes. 3

6 STEP 2. DETERMINE THE PLAN S PERSPECTIVE ON THE ROLE OF DIVERSIFICATION The remaining two considerations in the Target Date Compass questionnaire help plan sponsors assess their views on the role of diversification as a way to improve portfolio outcomes as well as their preferences for more or less traditional asset classes. THE AMOUNT OF DIVERSIFICATION NECESSARY TO IMPROVE PORTFOLIO OUTCOMES Some investment managers believe that risk-adjusted return potential increases as asset classes are more broadly diversified. Other managers, however, believe that while broader diversification may mitigate risk and manage volatility, it may not ensure enhanced outcomes. This consideration helps plan sponsors rank their views on whether they agree or disagree that broad diversification may improve portfolio outcomes. PREFERENCE FOR TRADITIONAL OR EXTENDED ASSET CLASSES Department of Labor (DOL) rules state that plan sponsors must consider a blend of asset classes to achieve a balance between risk and return when creating their investment programs. This consideration helps plan sponsors assess their preference for relying on traditional asset classes with low correlation to one another, or including less traditional asset classes such as high yield, emerging markets debt, commodities, Treasury Inflation-Protected Securities (TIPS) and real estate in portfolios to diversify and manage risk and return. IMPLICATIONS: The answers to two questions relating to these considerations will yield a diversification score that indicates plan sponsors preferred level of diversification in their TDFs. 4

7 STEP 3. IDENTIFY THE TARGET DATE TYPE SM The cumulative scores of the first three questions yield an equity exposure score that determines where the plan is plotted on the x-axis on the Target Date Compass Quadrant Map, while the answers to the fourth and fifth questions yield a diversification score that determines where the plan is plotted on the y-axis. The higher the equity exposure score, the further to the right or ( east ) on the map the plan will be placed; the higher the diversification score, the further up or ( north ) the plan will be plotted. EQUITY EXPOSURE DECODING THE TARGET DATE COMPASS QUADRANT MAP DIVERSIFICATION LOWER HIGHER HIGHER LOWER The Target Date Compass Quadrant Map is a twodimensional grid with four quadrants. Each quadrant corresponds to a particular Target Date Type. Plans plotted within any one quadrant have similar goals and expressed preferences for equity levels at the target date and asset diversification. For example, TDF families in the northwest or upper left quadrant seek a lower level of equity at the target retirement date but a higher number of asset classes. Conversely, plans plotted in the southeast or lower right quadrant are characterized by a preference for higher equity levels at the target date but relatively fewer asset classes. 5

8 STEP 4. COMPARE AND SELECT THE MOST APPROPRIATE TARGET DATE FUNDS Once the plan has been plotted onto a particular quadrant, plan sponsors can compare TDF families that correspond to their plan s Target Date Type and select the family they believe to be best suited to meeting their plan s goals and the needs of their participants. A critical component of the evaluation process is a detailed Target Date Compass Analysis Report, which provides robust, comparative analytics, using publicly available and third-party data from Morningstar Inc. The detailed report can help plan sponsors evaluate and compare TDF strategies that are suitable for the plan. Highlights of the analysis include: An asset class summary that assesses TDFs based on their exposure to 12 asset classes Equity glide path comparisons that show how TDFs equity allocations change over time Comparisons of TDF strategies performance, fees and investment expenses, as well as riskand-return characteristics Charts that compare the growth of $10,000 across selected strategies Characteristics of each of the Target Date Compass s four quadrants THE IMPORTANCE OF ONGOING REVIEW As the universe of TDFs continues to evolve, the Target Date Compass program helps plan sponsors establish an effective process to periodically review and monitor their plans TDF. At a minimum, the review process should include an examination of whether there have been changes in participant behavior or the fund s structure. 6

9 Target Date Compass provides material assistance to fiduciaries. It helps them fulfill their obligations to consider the needs of the plan and its participants, to select a TDF family that is consistent with those needs, and to document their process. 4 Fred Reish and Bruce Ashton Drinker Biddle & Reath LLP FIDUCIARY CONSIDERATIONS As fiduciaries, plan sponsors remain responsible and potentially liable for the proper selection and monitoring of a TDF family used as their QDIA. TARGET DATE COMPASS IS DESIGNED TO HELP PLAN SPONSORS MEET THOSE FIDUCIARY AND REGULATORY REQUIREMENTS BY: Establishing a process for evaluating, selecting, and monitoring TDFs Clarifying plan goals and identifying participant behaviors and matching these goals to a particular type of TDF Documenting the selection and review process, including how fiduciaries reached decisions These considerations are also factors that the DOL has stated fiduciaries should take into account when designing the investment menu of a DC plan. 5 Target Date Compass provides a framework for evaluating TDFs, a step-by-step process to prudently select a TDF family that is aligned with the needs and goals of the plan and its participants, and a mechanism by which to document the process. Target Date Compass facilitates productive conversations about a plan s objectives, risk tolerance, demographics and expected participant behaviors. 4 Analysis of the J.P. Morgan Target Date Compass SM, February Fred Reish & Bruce Ashton: Drinker Biddle & Reath LLP 5 U.S. Department of Labor, Target Date Retirement Funds Tips for ERISA Plan Fiduciaries, February

10 THE BENEFITS OF TARGET DATE COMPASS SM INCLUDE: IMPARTIALITY: Provides unbiased analytics for evaluating TDFs PROCESS: Follows a well-defined, repeatable approach that helps plan sponsors meet their fiduciary responsibilities in selecting TDFs DOCUMENTATION: Helps plan sponsors make prudent, defendable QDIA choices RESULTS: Assists in identifying a TDF that best aligns with a plan s goals and objectives The obligation of plan sponsors to act prudently in making an appropriate TDF choice is more important than ever. By establishing a prudent process for comparing and selecting a TDF, as well as a mechanism to regularly review TDFs, the Target Date Compass program can help plan sponsors meet and even exceed their fiduciary requirements. 8

11 In a world of evolving target date funds, TARGET DATE COMPASS SM helps point you in the right direction.

12 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 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. A fund of funds is normally best suited for long-term investors. 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. J.P. Morgan Funds are distributed by JPMorgan Distribution Services, Inc., which is an affiliate of JPMorgan Chase & Co. Affiliates of JPMorgan Chase & Co. receive fees for providing various services to the funds. JPMorgan Distribution Services, Inc. is a member of FINRA/SIPC. J.P. Morgan Asset Management is the marketing name for the investment management businesses of JPMorgan Chase & Co. and its affiliates worldwide. Copyright 2014 JPMorgan Chase & Co., All rights reserved. Any and all information set forth herein and pertaining to the Target Date Compass and all related technology, documentation and know-how ( information ) is proprietary to JPMorgan Chase Bank, N.A. ( JPM ). U.S. Patents No. 8,255,308; 8,386,361 and patent(s) pending. RI-COMPASS BRO 0414