Taking a Closer Look at Target-Date Funds

A consultant at Russell Investments offers 12 nuggets of advice for selecting target-date funds for DC plans.

As someone who has helped select target-date funds, Josh Cohen, senior consultants at Russell Investments, says they can’t be evaluated like any other fund. There is a different approach than what some sponsors are used to do. In a recent paper, he shares the following observations:

1. Target-date funds should be designed with specific objectives in mind. Asset accumulation is only a part of that. “A target date fund series is not merely a set of portfolios designed for different points in someone’s life. Rather, it should be seen holistically as a continuous retirement program designed to meet specific objectives,’ Cohen says.

2. Glide paths slope down because of contributions, not because of time horizon. Cohen suggests that younger investors should not be more aggressive because they have more time to make up for losses, but because they have more human capital that acts like a bond. That distinction drives fund design in many ways, he asserts.

3. Risk should be measured in terms of not meeting retirement objectives. “Point-in-time measurement of asset return volatility is meaningless in a 40-year savings program,’ Cohen says. Instead, risk should be a measure of meeting retirement goals—and, he notes, that is not the same thing as running out of money.

4. There should be high equity allocations at the beginning of the glide path. As aforementioned, Cohen says people can afford a risky profile at the start of their savings.

5. There should not be high equity allocations at the retirement end of the glide path. Cohen rejects the strategy of continuing equity investments at retirement, suggesting it might work for some investors, but negative returns could be devastating. “By retirement, there are no more future contributions to offset the risk in the investment portfolio,’ he says.

6. There is no clear investment rationale for the glide path to continue to slope down after retirement. Cohen says asset allocation at retirement should be more a judge of how the investor reacts to experience than to time. So to be safe with everyone, a flat glide path is best, he says.

7. Target-date solutions should provide diversified sources of return. It is OK to offer volatile asset classes like REITs or emerging markets—as part of a broader portfolio (and not standalone), they make sense to offer diversification.

8. Passive should not be considered the safe choice. Cohen says passive investing might be good for some—but not all plans are coming to that conclusion in a way that is in the best interest of the participants.

9. Proprietary managers face headwinds. These managers are challenged to present objectivity and prove a best-of-breed approach, Cohen says. Plan sponsors need to evaluate themes across underlying strategies from providers, as well as the ability to gain access to capacity-constrained strategies in the target-date fund, he says.

10. Building a custom target-date fund is harder than it sounds. Plans looking to build a customized target-date fund need to make sure they have the appropriate staff resources, the right amount of assets to make it cost-efficient, and a solid partner—an maintain this structure for the long term.

11. Take care with performance comparisons. As the industry strives for more efficient ways to evaluate fund performance, Cohen says target-date funds need to be evaluated as how well the fund family builds retirement income, not as raw returns numbers from individual funds.

12. Target date funds cannot solve all of a plan’s problems. In case sponsors and advisers have forgotten, Cohen reminds that no matter how great the target-date design, it will not solve the savings shortcomings of participants.

The full paper can be accessed here..

See also: An Elusive Target, Inveset-O-Matic, Target-Date Funds Might Overshoot Equity Target, Examining the Glide Path Methodology for Target Maturity Funds, Key in Target-Date Funds: Diversity and Downside Protection, Most Target Date Fund Strategies Flawed

PLANSPONSOR also offers help evaluating target-date funds via its interactive buyer’s guide at www.plansponsor.com/lifestyle and recently updated analysis of target-date fund families is available for purchase at http://www.plansponsorresearch.com/targetdate/.