PLANADVISER: Target date strategies are more complex now than they were when first introduced. How do advisers approach selection and evaluation of these options, and how has that evolved?
Ruthann Pritchard: Twenty-one years ago, Fidelity became a pioneer in target date investing with the launch of the Fidelity Freedom Funds. Plan sponsors embraced the strategies, but it was another 10 years before target date investing really took hold with the groundbreaking Pension Protection Act of 2006 [PPA]. At that time fund adoption and usage gained significant traction and with that development there was also significant growth in the number of target date providers. Many employers were also shuttering their defined benefit [DB] plans, leaving defined contribution [DC] plans and target date strategies as the primary retirement savings vehicles for many investors. All combined, these events led to an evolution within the target date industry including the incorporation of many of the principles, beliefs and investment strategies that are at the core of DB investing.
In selecting a target date strategy It’s important to understand the goal of the strategy and what research led the investment manager to select that particular goal. Then, ensure the investment philosophy, beliefs, and implementation of the strategy align with you and your clients goals.
Performing due diligence on the glide path is key. It’s important to understand how the glide path was developed and how the research supporting the glide path manifests itself in the roll down [the change in asset allocation over the time horizon of the investor].
Understanding implementation is also important. How is the target date provider achieving investment return beyond the strategic asset allocation? Are there additional asset classes, investment strategies, active asset allocation and/or active security selection that the provider has access to that can potentially improve outcomes? How have those strategies performed?
With respect to fees and resources, the question to ask is whether or not you believe that you are getting good value for the fees being paid. In the case of a target date strategy “good value” is not just historical performance but the ability to deliver future performance and long-term outcomes. A provider has to have the resources and commitment to evolve the strategies over the long-term.
PA: Beyond some of those criteria you already mentioned, what does the Department of Labor [DOL] suggest advisers do when selecting and then monitoring a target date strategies provider?
Pritchard: Guidance from the DOL largely centers on due diligence. The adviser and the plan sponsor should consider performing sufficient due diligence during the selection process and ongoing monitoring, to be able to assert that they understand the target date solution the participants are invested in and that the philosophy and beliefs of the investment manager surrounding target date investing align with those of the fiduciary.
The DOL outlines the importance of having a process and documenting that process, and so for many plan sponsors, this includes an Investment Policy Statement [IPS] which can be a challenge with target date strategies. Standard performance and peer comparisons are generally not helpful given that all glide paths are unique to the provider, there are no industry benchmarks, and peer groups don’t account for differences in glide path and implementation. As a result, some adviser and consulting firms have removed target date strategies altogether from the IPS, others have just removed peer group comparisons.
PA: One thing that’s been a challenge since target date strategies appeared is, without any sort of given industry benchmark for target date strategies, and with such differing strategies from fund to fund, how can an adviser and plan sponsor effectively measure the performance of these investments?
Pritchard: It has to be a multi-pronged, or mosaic, approach. Given that there are no industry standard glide paths or benchmarks, fiduciaries cannot easily compare performance across providers and strategies. Evaluating performance against the investment manager’s stated goal or objective and relative to its own benchmark are important. While direct peer comparisons can be difficult in target date strategies, understanding performance relative to peers can also be helpful.
At Fidelity we use our strategic asset allocation as our benchmark. Any decision above and beyond the asset classes and allocations within the strategic glide path are active decisions. Other target date providers might use a roll up of all of the benchmarks of the underlying funds as a top level benchmark for the funds. In this case relative performance might be a measurement of the skill of the underlying managers making active security selection decisions, but may not give any insight into the success of asset allocation decisions made by the manager.
Peer comparisons are challenging, not only because each provider’s glide path is different, but because generally all target date strategy peer groups are categorized by target year, meaning that active, index and blended implementations, as well as “to” and “through” providers, are all included in the same category.
PA: How does Fidelity think about value in relation to target date strategies investments?
Pritchard: We don’t believe that “value” means paying the lowest fee in the marketplace. We believe that value is paying a competitive and fair price for a deep team and resources that can potentially deliver strong participant outcomes throughout retirement.
One strong and positive trend that we continue to see evolve in the market is that plan sponsors are designing their DC plans to provide potential retirement income for participants. This means that plan sponsors are reviewing benefits design and including automatic enrollment and auto-increase as part of the plan. It also means that they are reviewing plan design as it pertains to withdrawal provisions and loans
to reduce leakage and allow participants to stay in plan. That commitment also means that from an investment option standpoint they are hiring target date providers that can help achieve retirement income for their participants. Value to these plan sponsors is aligning with a partner who has the capabilities and resources to do that at a competitive cost. At Fidelity we offer low-cost solutions and product choice flexibility with active, index, and blended strategies.
PA: What else should advisers consider when presenting the target date strategies discussion to their plan sponsor clients?
Pritchard: We just released a whitepaper that highlights the need to build a resilient glide path. Building a glide path that is resilient to different market environments is key to long-term success. Additionally, having the investment flexibility, beyond the strategic glide path, to potentially capitalize on market opportunities and avoid areas of market stress can be a key part of a successful target date strategy.
We have talked a lot about plan sponsor and fiduciary education but participant education is also important. As the default fund for many plans, participants may not know what they are invested in and Fidelity believes that educating a participant as to what a target date strategy is, how it works and why it may be the right investment option, is very important.
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Unless otherwise disclosed to you, in providing this information, Fidelity is not undertaking to provide impartial investment advice, or to give advice in a fiduciary capacity, in connection with any investment or transaction described herein. Fiduciaries are solely responsible for exercising independent judgment in evaluating any transaction(s) and are assumed to be capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies. Fidelity has a financial interest in any transaction(s) that fiduciaries, and if applicable, their clients, may enter into involving Fidelity’s products or services.
Target date funds are designed for investors expecting to retire around the year indicated in each fund’s name. The funds are managed to gradually become more conservative over time as they approach the target date. The investment risk of each target date fund changes over time as the fund’s asset allocation changes. They are subject to the volatility of the financial markets, including that of equity and fixed income investments in the U.S. and abroad, and may be subject to risks associated with investing in high-yield, small-cap, and foreign securities. Principal invested is not guaranteed at any time, including at or after the funds’ target dates.
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