It takes a lot of experience and conviction to feel confident in running a multi-billion dollar target-date fund (TDF) series.
A skilled team of investment researchers and on-demand technical support from one of the world’s largest investing institutions doesn’t hurt either, says Dan Oldroyd, portfolio manager and head of J.P. Morgan’s target-date strategies.
Speaking recently with PLANADVISER, Oldroyd suggests it’s an engaging and challenging time to be running a large, name brand target-date fund series—and on that note, it’s also an interesting time to be invested in such a product. The industry is closing in on the 10-year anniversary of the Pension Protection Act (PPA), which effectively set the stage for widespread automated investing within retirement plans in the interest of preventing poor decisionmaking by uninformed investors. At the same time, geopolitical and economic forces are trying investment strategies up and down the markets, testing the resolve of sophisticated institutional investors and novice TDF owners alike.
Add to the soup the latest thinking on behavioral finance and the wide embrace of goals-based investing, and one can see some of the powerful countercurrents that must be considered in building out a TDF strategy.
“In the initial years following the enactment of the PPA, the industry was more focused on testing and proving the basic TDF glide path concept and teasing out key similarities in investment outlook among seemingly diverse retirement plan populations,” Oldroyd explains, citing his firm’s own decade-old “Ready! Fire! Aim?” research program. “This played out in the to-versus-through debate and the related debate about how much equity to have in the glide path, for example. More recently, I think we have started to move on to think about how things like cash flows, participant loans, the timing of withdrawals and the variability of inflows all combine to impact TDF performance.”
Oldroyd likens the effort to “bringing the theoretical effort of building and implementing a portfolio glide path into the real world setting of a retirement plan,” where people do not behave exactly the way mathematical models would suggest. He says the “equity versus fixed-income question will obviously remain important,” but he is particularly interested in emerging questions around how the variability of cash flows into a TDF portfolio can significantly impact performance over time, and whether the effect is significant enough to impact glide path construction and other elements of TDF strategy.
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“Participant behavior remains incredibly important even in a post PPA-world where many people are using target-date funds and other aspects of automation,” Oldroyd continues. “It’s another side of the argument that investment allocation is only one piece of the puzzle in building a successful retirement.”
Oldroyd feels some of the key questions for plan sponsors and advisers to consider in picking and monitoring a TDF are fairly obvious: “Should the role of a TDF be to earn as high a return as possible? Or, should it be to secure a minimum level of success for as many people as possible? Do you protect what you have, or do you try to grow to make up the gap?”
But others are more esoteric: “What is the impact of the timing of inflows on an individual’s short- and long-term performance in the TDF? How long after making their first investment into a TDF is a given investor reaching an appropriate deferral level of at least 8%? What about 10%? Is this happening quickly enough to ensure retirement readiness? What impact does current salary and potential raises have on deferrals? Are people still getting raises so they can keep ramping up their contributions in the way your TDF model says they need to in order to reach retirement readiness?”
Sadly, Oldroyd says the latest data shows sponsors’ answers to this second batch of questions might actually be getting worse post-PPA. “In our original ‘Ready! Fire! Aim?’ research from a decade ago, for example, we saw people reaching sustained 8% salary deferrals around age 40 on average, but today this doesn’t happen until very close to age 50. Even worse, a decade ago people were peaking at about 10% of salary contributions on average by age 55 and holding there for a time before retiring, but these days most people aren’t even getting there pre-retirement.”
In short, Oldroyd says TDF managers and owners are realizing that these challenges all have to be factored into both plan design and investment design. Given the fact that raises are only very modestly outpacing inflation, for example, it's not likely TDF owners will be able to pour more money into their retirement accounts late in their careers to make up for lower contributions today. Nor is it likely a good move to ramp up equity exposures right now to cover potential income gaps in retirement.
“That would simply require too much risk at this point,” Oldroyd warns. “Any real solution is going to have to be holistic and look across all these elements.”
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Oldroyd goes on to explain that “PPA has driven so many more people into plans via auto-enrollment, and that is a great thing.”
“But what we are starting to see clearly now is that auto-features are seemingly more helpful for new employees, as is auto-escalation,” he warns. “Increasingly we have a big swath of employees who haven’t been caught up in all the automation and who are being left to their own devices.”
Plan sponsors should understand whether their plan is being divided into these two populations, Oldroyd suggests. Recordkeepers should be ready and eager to help here, supplying any necessary data about how participants are invested and whether this has any noticeable impact on loans, timing of withdrawals, the timing of the increases in deferrals, etc. If the answer is yes, action should be taken to ensure everyone in the plan is getting a fair shot at success.
“A simple way to explain this issue is to think about the difference between retirement projections and the reality participants experience,” Oldroyd concludes. “It’s pretty easy to imagine a retirement plan in which an individual would be projected to do well given a certain set of data (say, salary and age) but would actually fail to reach retirement readiness—perhaps through a combination of poor financial decisionmaking and bad luck in the markets. It’s important for plan sponsors to understand this possibility and how to address it through plan design, benchmarking, reporting, etc.”