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What is the End Game With Target-Date Funds; Retirement or Death?

By Jeb Graham, CEBS, CIMA® Accredited Investment Fiduciary®, of CapTrust Financial Advisors, an independent consulting/advisory practice focused on the institutional retirement plan market, serving corporate, closely held, non-profit and governmental organizations. You may contact Jeb at 813.218.5008 or jeb.graham@captrustadv.com.


An article recently published in a retirement plan industry journal addressed criticisms of the construction of Target-Date Retirement portfolios that are based on a "through" retirement approach. The term "through" retirement implies that the glide-path, the formula by which the portfolio's asset allocation rebalances over time, carries through retirement to death. This strategy is contrasted by the "to" retirement approach, in which the glide-path is designed to end, or become static, at retirement, as opposed to death.

The article responded to charges that most near-term (2010) target-date funds (TDFs) were much too aggressively invested in equities, and the harm caused to TDF investors in 2008 could have been avoided. The author, in his response, used universally accepted financial planning themes to support the conclusion that an individual's asset allocation at normal retirement date of 65 should be in the neighborhood of a 50% stock/50% bond mix, thus justifying a 2010 TDF with such an allocation. Maybe the bigger question is not really what percentage is allocated to equities, but rather, what is the end game, i.e. retirement or death?

On the surface, the case for the "through" approach is a rational argument, based on historical rates of return and patterns of inflation, combined with increasing life expectancies. But this view implies that a DC plan participant, upon choosing a TDF, makes a decision that is intended to carry through until his or her death. In my opinion, very few participants followed this thought process. My sense is that at the time of initial TDF selection, most plan participants thought they were buying "to" funds with the goal of reaching retirement, as opposed to "through" funds, with the end game being death. If this misperception is common, a large number of plan participants are likely not being well-served.

Perhaps the most glaring problem with TDFs is an overall lack of understanding of the products in general….of the assumptions, the portfolio construction, the strategy and the underlying method of execution. Retirement plan committees making the purchase decisions often don't understand the differences in the alternative products available. I believe participants understand even less, despite the surge of dollars into TDFs over the past few years.

What Target Are We Aiming At?

It depends on one's view. The term target-date retirement would seem to suggest an end game at the stated date, rather than at death. This premise holds that the TDF has done its job by getting the participant to retirement. Because the distribution decision is too complex to be solved with a "one size fits all" approach, an individual's portfolio construction going forward after retirement from the plan sponsor should be separate from the DC plan portfolio. That a TDF portfolio is conservatively allocated at date of retirement does not mean the individual should remain in that allocation during retirement.

In reality, however, many plan participants lack sophistication in their approach to retirement, and end up on the path of least resistance. The distribution decision may end up undecided and not executed, resulting in no change to the investment portfolio. From an investment standpoint, one could make the argument that "through" funds minimize the need to make portfolio changes at retirement, thus producing a more appropriate long-term allocation for the unengaged participant that is permanently on auto pilot.

Current Product Landscape

Most target-date funds are constructed as "through" funds, with the end game being date of death, rather than date of retirement. The argument for a lifetime allocation notwithstanding, a bigger reason for the bias toward "through" funds might be a function of the business model of the firm behind the product. The Big Three (Fidelity, T. Rowe Price and Vanguard), with roughly 75% market share, have a common theme underlying the TDF construction in that their business model is predicated on asset retention as a result of rollovers from DC plans to IRAs at retirement age. When these products were being developed in the 1990s, the assumption was that most DC plan participants would make very few investment changes during their working life, and at retirement, elect to roll over their account to an IRA in the same investments. Most of the early stage products followed this assumption. Little difference existed between most TDF products…usually comprised of proprietary funds with similar allocations.

As the products evolved, and the underlying investments and glide-path construction became subjected to review and benchmarking analysis by the investment community, alternative approaches were formulated. The range of investment allocations for similar date funds varied dramatically...which brings us back to the previously referenced problem. The general level of understanding by retirement plan committees, as to the differences in the products, is slowly moving up the learning curve, but for many plan sponsors it is still not adequate to make informed choices. Most TDFs being used by participants today were selected simply because that was the proprietary product their plan vendor offered. There has traditionally been minimal transparency as to the investments being used in portfolio construction.

Going Forward

There seems to be two prevailing trends with respect to TDFs. First is a shift away from proprietary products toward a more custom approach, in many cases using the same portfolio as is offered on the core menu. The idea is simple…use fiduciary best practices to build a best in class menu, monitor on a consistent basis, and build the TDFs from the same investments.

The second trend is a shift toward more conservative TDF glide-paths, resulting from several factors. Plan committees have begun to recognize that "to" funds carry less downside risk to the plan sponsor. Irrespective of financial planning wisdom, the typical VP of Human Resources wants to avoid having retirees question why their TDF portfolio is 50% invested in equities. Another factor is the new products being rolled out that combine TDFs with a risk-based profiling component, creating a hybrid TDF that allows much greater flexibility in managing risk. The third factor is the separation of the asset accumulation phase from the distribution phase. Being in a conservative portfolio approaching retirement doesn't mean you have to stay there, but it does seem to simplify, for many retirees, the complex distribution decision. All three of these factors would seem to tilt the TDF landscape toward the "to" retirement approach, moving away from the "through" approach upon which most of the products were originally built.

In my opinion, these two trends are likely to meaningfully impact TDFs in the industry. As TDF products become better understood by both plan sponsors and participants, I believe we will see a significant change in the way TDFs are built and delivered.

This material is distributed solely for information purposes and is not a solicitation of an offer to buy any security or instrument or to participate in any trading strategy. The views contained herein are the opinions of the author. It is not intended as legal or tax advice.

CapTrust Advisors, LLC is a registered investment advisor with the SEC. CapTrust is not a legal or tax advisor.


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