The Markets October 16, 2017

PANC 2017: Measuring TDF Performance

Against the background of strong equity market performance in the last seven or eight years, passive target-date funds now account for 42% of the TDF market, compared with 27% in 2009. 
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The second day of the 2017 PLANADVISER National Conference in Orlando featured an extensive conversation on the difficult topic of measuring target-date fund (TDF) performance.

Including the moderator, the panel discussion featured a team of five retirement plan industry veterans: Brooks Herman, vice president, data and research, Strategic Insight; Joe Szalay, vice president for defined contribution (DC) investment strategy, BlackRock; Todd Leszczynski, managing director, MFS; Derek Young, head of investment client strategy, vice chairman, Fidelity Institutional Asset Management; and Todd Lacey, chief business development officer, Stadion Money Management.

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As the panel laid out, passive strategies now account for 42% of the entire TDF market, compared with 27% in 2009. This growth in passive approaches is coming from large and jumbo plans looking to reduce fees, mainly, but it also extends into the midsize and smaller DC plan market. The panelists voiced some concern about this fast growth and questioned whether plan sponsors understand what could happen to passive TDFs during a sharp market downturn.

Alongside the trend of a strong shift toward passive management, the use of collective investment trusts (CITs) as a means of target-date investing continues to grow, with 52% of net TDF assets now invested through this type of vehicle. There is also some emerging evidence that the use of exchange-traded funds as the basis for target-date portfolios is increasing, though far more slowly than that of CITs.

The panelists all agreed that, while TDFs are known for their simplicity of use, this is something of a mischaracterization. It is true TDFs are relatively easy to use from the participant perspective, but there is a significant amount of preliminary and ongoing analysis required of the plan sponsor and the adviser to ensure the appropriate TDF strategy is put in place. Some of the panelists seemed to favor the approach of offering multiple glide paths to a given plan population within the same target-date product family, while others were more comfortable with the idea of finding a single, middle-ground glide path for the plan population. In either case, the panelists agreed that the adviser has a crucial role to play in helping sponsors identify, consider and ultimately select the best TDF approach for their plan.

Important to note, the panelists mainly agreed that the only trend that may slow the growth in TDFs would be growth in managed accounts. They stressed that there is an emerging conversation about pairing TDFs and managed accounts together on the plan menu to serve people with simpler needs vs. those with more specific, individual needs. The idea is that a newly employed 25-year-old with his first DC account probably will be better served by a TDF, whereas older workers with greater amounts of retirement savings could be better served by managed accounts.

Other topics that were broached during the panel discussion included the unfortunate fact that many plan sponsors utilizing passive target-date funds believe that doing so absolves them of fiduciary responsibility—a completely inaccurate assumption that advisers should combat. Further, the panelists considered the relative importance of screening the target-date fund as a whole compared with screening the individual investments built into that TDF. Especially when proprietary options are being used, there may be investments within the TDF series that would not necessarily pass a plan sponsor’s scrutiny were they considered on their own as stand-alone options for the core menu. 

The Markets October 16, 2017

PANC2017: Improving Plan Design for Retiring Participants

Participants age 50 and older need more personalized advice, advisers say.
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“Target-date funds [TDFs] may not be appropriate for everyone,” said Clint Barker, senior vice president, retirement investment solutions at PGIM Investments, the asset management group of Prudential, speaking at the “Improving Plan Design for Retiring Participants” panel at the 2017 PLANADVISER National Conference (PANC), Thursday. “Everyone is not the same.”

Helping people approaching retirement “is one of the key questions we spend our time on at Franklin Templeton,” said Tom Waters, senior institutional DC strategist, Franklin Templeton Investments. Helping people retire really means “working with people over age 50 who are thinking about retiring. This group is drastically different from the monolith called ‘the participant base.’ Sixty percent of the assets in the DC [defined contribution] system are with people 50 and older.”

Advisers need to realize that participants in that age group are very engaged with their retirement savings—and looking for personalized help, Waters said. “Among the married people age 50 and older, only 39% of their assets are in a DC plan. They have assets in other plans. This is only a piece of the puzzle,” he said. “Financial Engines’ TDF study found that 95% of TDF investors use other options. Fifty-four percent said it was because their TDF wasn’t aggressive enough or was too risky. We need to build better DC plans for this group. People are more engaged than we give them credit for.”

Jeffrey Bograd, director, managing ERISA [Employee Retirement Income Security Act] consultant at John Hancock Retirement Plan Services, said a big part of helping people approaching retirement is focusing on life after retirement, taking into consideration that “people are living longer, returns are projected to be lower, and, today, people have less access to pensions with guaranteed income.”

NEXT: ‘The bigger challenge’

“The accumulation stage is not that challenging,” Bograd continued. “We know what works: automatic enrollment, sweeps, TDFs, making a 6% initial deferral rate the ‘new 3%.’ The bigger challenge is going from 65 to 95 without outliving your savings. People need advice. They get only one chance at retirement.”

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Advisers need to help retirees with a “drawdown strategy,” he said and suggested they urge them to “fill up lower marginal tax brackets such as a Roth plan or a 401(k) before their brokerage accounts. [An effective drawdown strategy] could also [mean] developing Roth conversions to delay taking Social Security until age 70,” he said.

Managed accounts and personalized attention are the real key, Bograd said, noting that, as the industry begins to make more effective use of “big data,” advisers may start to understand each participant’s unique situation and be able to help him make the right investment and drawdown decisions in retirement. “Ask them health questions,” Bograd said. “Look at their marital status, their zip code—to determine their individual situation. Figure out their expenses each year because we know there are the ‘go-go years, slow-go years and no-go years.’”

Franklin Templeton suggests to many of its clients that they offer retirement plan participants four different investment tiers, Waters said. The first is a TDF, as the default option. Tier two is a core menu, to allow the participant to customize his allocation. Tier three is a brokerage window, and tier four is the retirement tier that includes “investment options, plan design changes, targeted communications and tools for retirement,” he said.

NEXT: Catch-up

 

Many employees ages 50 and older are unaware of the Internal Revenue Service (IRS) catch-up provision that allows them to invest an additional $6,000 in their 401(k) plan, on top of the maximum allowed $18,000, for a total of $24,000, Waters noted. Franklin Templeton educates this age group about that option, he said, along with a plethora of investment options, including “GMWBs [guaranteed minimum withdrawal benefit annuities] and other guaranteed income choices, managed payout strategies, TIPS [Treasury inflation-protected securities], diversified inflation strategies and partial withdrawals. Even offering them a Social Security optimization tool makes a huge difference.”

Bograd added that those offerings should also include “longevity annuities that kick in at age 85.”

According to Barker, advisers should recommend more conservative TDFs for participants in the “red zone,” which he defined as the 10 years prior to retiring and the first 10 years in retirement. These investors need TDFs that offer “downside protection by de-risking through the glide path or offer income guarantees.” By providing these safeguards, there is a better chance to  encourage people to remain invested, he said.

John Hancock is a big proponent of Roth options, as 77% of U.S. households are in a 15% tax bracket or lower, Bograd said. “Roth options can have an incredibly positive impact for lower-paid people, those making $50,000 or less,” he said. “For highly compensated employees [HCEs], put them in an after-tax contribution option, such as a ‘mega back door’ Roth 401(k) or IRA [individual retirement account].” These options permit an employee to contribute up to $54,000 of salary each year, Bograd said. However, advisers need to make sure that, by offering these options to HCEs, it does not set up the plan to fail nondiscrimination testing, he warned.

 

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