feature | PLANADVISER June/July 2012

Rethinking Lifecycle Funds

Evaluating whether a target-date fund family is still the best solution

By Judy Ward | June/July 2012
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Illustration by Victo Ngai

“We are going through the next cycle of target-date fund [TDF] awareness,” says Doug Murray, director of sales and investments at Wells Fargo Institutional Retirement and Trust. “When target-date funds were first coming into prominence, some plan sponsors tied the target-date fund decision directly to the platform decision. Now there is a much more systematic view. Plan sponsors need to do a much more thorough evaluation, not just [ask], ‘What is the one-, three- and five-year performance?’”

For sponsors evaluating their plan’s target-date funds, also known as lifecycle funds, advisers can help bring clarity to these five areas:

1) Evaluate whether the glide path reflects the sponsor’s philosophy. Many sponsors initially just accepted their recordkeeper’s target-date funds and now need to decide whether these actually work best for that particular plan. “From a fiduciary perspective, the plan sponsor needs to take a step back and understand [the plan’s] objective,” says Tim Walsh, a TIAA-CREF managing director. “Is the plan meant to be an accumulation plan or a retirement-income plan?”

J.P. Morgan Asset Management offers the Target Date Compass, an adviser tool used to help a sponsor decide which of four target-date types works best for that plan, and then map out which particular managers mesh best with the employer’s plan goals and work-force needs. Advisers should help sponsors achieve a good sense of how they view risk, such as which type matters most for those participants, especially among longevity, inflation and market risks (particularly near or in retirement). “It does somewhat come down [to] a philosophical discussion and their tolerance for, at age 65, participants having a major market event and seeing their capital greatly reduced,” says John Galateria, a managing director at J.P. Morgan.

Market risk looms large in the strategy of some target-date providers. ING U.S. Retirement’s glide path begins more aggressively with equity than some because people have time to absorb the volatility, says Marianne Sullivan, head of investment information services. “As people approach retirement, our glide path tends to be more conservative than some others’. The five years or so prior to retirement are the most important in terms of downside risk.” And if someone’s account drops sharply a short time after retirement, she says, “it is very possible that he or she can never make up that loss.”

American Century Investments also relies on the “to”  approach. “Financially speaking, the riskiest day of your life is the day you retire,” Senior Portfolio Manager Richard Weiss says. “At retirement, you should be at your minimum risk posture. A target-date fund is built for the entire life cycle, to hold. But it does no good if the ride is so wild that an investor cannot, or will not, hold on.”

Others point to longevity risk. The glide path of TIAA-CREF’s TDFs, which focuses on the not-for-profit and higher-education markets, continues until age 75, Managing Director Randall Lowry says.

TIAA-CREF participant demographics explain the decision to continue the glide path past retirement. “The[se participants] have a longer life expectancy than the general population, so they have a heightened longevity risk,” he says.

Someone who retires at age 65 and lives until 90 needs another 25 years of asset allocation, says Jeff Tyler, a Principal Funds portfolio manager. “The ‘through’ retirement philosophy is essentially saying that retirement, while certainly an important event, is not quite the all-encompassing event that a lot of people think. A lot of people plan to be partially employed in retirement, and a lot of [actively employed] people do not know whether they will retire at 65 or at 70.”