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How to put retirement on autopilot with Target Date Funds
Target Date Funds are a great tool when planning for retirement. Watch as three experts discuss key things to consider when selecting Target Date Funds as a retirement product.
Glenn Dial - Managing Director Head of US Retirement Strategy at Allianz Global Investors
Bruce G. Picard, Jr., CFA - Chief Investment Officer, Asset Allocation Retirement Services/Investment Services Investment Director and Portfolio Manager at MML Investment Advisers, LLC
Rich Weiss - Sr V.P. and Sr Portfolio Manager Asset Allocation at American Century investments
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Duration:
01:03:26
Transcript:
Courtney: Welcome to Asset TV’s Target Date Fund Investing Master Class. Joining us today from our New York studios are: Glen Dial, Managing Director, Head of US Retirement Strategy, Allianz Global Investors; Bruce G Picard Junior CFA, Investment Director and Portfolio Manager, Mass Mutual Financial Group and joining us from Boston, Rich Weiss, Senior Vice President and Senior Portfolio Manager, Asset Allocation, American Century. Gentlemen, welcome, and thanks for joining us for Asset TV’s Target Date Fund Investing Master Class. If there was ever a low maintenance retirement plan product, Target Date Funds would be it. Glen, tell us why Target Date Funds are a great solution for those who want to put their retirement plans on autopilot?
Glen: [00:00:40] That’s a good question. And when I think about Target Date Funds I think of a great investment product that was really designed for the delegators and a 401K plan. And when I think about delegators I think about participants who either don’t have the time or the knowledge to make their own investment allocation decisions. Therefore what’s unique about Target Date Fund or what’s good about Target Date Fund is that they have the year right next to them that you want to retire. So for example if you want to retire in 2030 you would pick the 2030 fund. And then a professional money manager will do all the asset allocation for you and it gets more conservative as you approach retirement date.
Courtney: [00:01:17] And, Bruce, Target Date Funds try to take a complicated scenario, investing over a 30 year time horizon and make it simple, explain how that works?
Bruce: [00:01:25] Well, I think what Target Date Funds are brilliant at is addressing the behavioral issues of investors. So over time most investors don’t want to be involved in it or don’t have the ability, and they tend to fall away as fads. And studies have shown that they tend to do things that are counterproductive. They chase whatever the latest hot investment is and maybe sometimes they just don’t touch their portfolios at all and they get out of bounds. And so you know, the reason Target Dates are so valuable and effective is because they take those counterproductive behaviors and turn them into a positive. So you get involved in a Target Date Fund, it’s easy to understand, it’s something that really is intuitive, people like it, plan sponsors like it, so on and so forth. So we just get involved and what can happen is they’re really simple on the surface, but they can be, under the hood they can be a little bit more complicated because you have investment professionals running the portfolio. So you get that balance, plan sponsors and participants certainly, you know, over time, should be, you know, reviewing and watching the portfolios. But they don’t have to do anything, that’s really what makes them effective.
Courtney: [00:02:35] And, Rich, Target Date Funds usually start out very heavily weighted in equities as you’re going out for say a 2050 fund and then as you get closer to retirement are more heavily weighted in fixed income, cash, and cash equivalents. Explain how that works.
Rich: [00:02:47] Well, this is what’s known as the glide path in Target Date investing. As one ages and presumably increases their financial wealth, it’s a well-known phenomenon both in academia and in the real world that risk aversion increases. In other words you can less afford a dramatic loss as you get older and near retirement and have built up most of the wealth upon which you’re going to need for the retirement years. And so the glide path just recognizes that fact and adapts to it by decreasing the risk posture or equity exposure as you progress through your working life or age. Ultimately as you reach retirement you would presumably reach the minimum level of risk posture that is the lowest equity exposure. So again, Target Date Funds are just recognizing the well-known phenomenon and the prudent investment strategy of reducing your risk exposure and your financial assets through your lifetime so that you can more safely and effectively and successfully retire.
Courtney: [00:03:50] And we have a question from one of our Asset TV viewers.
Steven: [00:03:54] My name’s Steven [unclear 00:03:55] with Retirement Plan Consulting Firm [unclear 00:03:58] New Jersey. So my question to the three panelists would be how are you addressing sequencing risk as it relates to the steepness or flatness of your glide path?
Courtney: [00:04:07] Bruce, how do you address the sequencing risk?
Bruce: [00:04:10] That is a risk that we design our glide path and as we manage the glide path we very specifically address. When you’re looking at a glide path you’re really sort of balancing growth over time and adjusting the risk over time. And you want to get to a mix of investment performance that drives returns but also along the way you want to try to have a return stream that doesn’t put too much pressure on the behavior of the actual participants. Those are the two key things. But one of the things along the way is as you’re assessing what your glide path should look like, you want to look sort of on average of what it does for the average participant. But you also want to make sure that there’s not one particular, we call it timing risk, we also consider them cohorts. So we sort of, any particular cohort who’s retiring at a particular period, you want to make sure that you’re not overly disadvantaging them one way or the other in so far as let’s say they retire in 2008, during the global financial crisis. So your glide path should adjust for the fact that you want to make sure that as you bring down the risk of the glide path over time, you’re balancing the growth so you want to have the risk level early in the years … in early years, excuse me, that is effective and growing. You want to bring that risk down but you want to do it in a way that gives people, if they do happen to retire during something like 2008 that you’re not locking in those down markets, those losses.
So you should have a slope, and we have a little bit of a kink right at retirement where you continue to have exposure to equities, have exposure to inflation fighting assets, those types of things. So that that one particular group or that sequence is not disadvantaged versus another that might have retired two years before or two years after.
Courtney: [00:05:51] And, Glen, how do you address sequencing risk?
Glen: [00:05:52] Yeah, and I think sequencing risk is one of the biggest risks facing potential retirees. And when you think about getting ready to retire, if a 2008 event hits again you’re talking about the average Target Date Fund, in this case a 2010 Target Date Fund went down 30% in year 2008. So can you imagine if you retired in 2008, your entire life savings went down by 30%? And then on top of that you start taking a 4% withdrawal on top of it, you’re not going to make that up. So in my mind sequencing risk is one of the largest risks facing 401K participants, it’s something we have to be informed of and aware of and manage it appropriately. So I think a Target Date Fund should do a good job at managing that sequencing risk and making sure there’s … you’re limiting that downside volatility as you’re getting that 5-10 year zone before retirement so you can preserve a lifetime of good savings and investment habits.
Courtney: [00:06:54] Rich, how do you approach sequencing risk?
Rich: [00:06:56] Well, sequence of returns risk otherwise known as path dependency is a less often talked about risk, but a very insidious risk. Because basically what it has to do with is the luck of the draw in investing. I mean if you were unlucky enough, for example, to have retired right at the end of 2008, right when you’ve built up the biggest nest egg for your retirement, that would be the unluckiest portion of time. On the other hand if you have a fortunate sequence of returns in your lifetime you’d retire right at the end of a bull market, so you get the extra return when you have your biggest pot of money and therefore it’s most beneficial to you. Now, no one can eliminate sequence of returns risk in Target Date or any type of investing. But there is a way to minimize or buffer an investor’s exposure from sequence of returns risk and that’s by flattening the glide path. At American Century we have one of the flattest glide paths in existence. In other words we don’t have any steep or dramatic movements over short periods of times from high risk to low risk. And this is one of the best ways to minimize the sequence of returns risk in one’s investing lifetime. The flatter your asset allocation through life or the more gradual the de-risking process, the less likely you’ll invite in bad luck into your element of investing.
Courtney: [00:08:30] Glen, what have we learned about loss aversion versus optimized glide path?
Glen: [00:08:34] Yeah. That’s, I think that’s the next frontier in terms of how we look at glide paths because right now when you look at a glide path for a Target Date Fund, it’s all optimized around risk return, trying to find that efficient frontier if you will. What we’re not taking into account is the behavioral aspect of it. And the behavioral aspect of it says, “Wait a minute, I’m loss adverse, especially as I start approaching retirement age I become hyper loss averse.” So how does that differ from what an efficient glide path looks like versus my loss adverse glide path? And usually what we find is there’s a gap in terms of what people can actually tolerate versus mathematically what is right to get them to the right return. So what we’re talking about is how do we address that gap? And what we saw in 2008 is that while most participants did not take their money out of their Target Date Funds during the financial collapse, the people that were closest to retirement, that’s 60 year olds and 65 year olds, did take their money out and they did lock in those losses. So addressing loss aversion, addressing the gap between efficient glide path and the loss adverse glide path I think is something we have to do a better job at in our industry.
Courtney: [00:09:49] And, Bruce, how do you differentiate between a TO versus a through glide path?
Bruce: [00:09:53] So you know, one of the key distinctions in Target Date Funds in general is sort of the to glide path versus the through, and this is just this idea of when you hit retirement, is that your point of most conservative allocation and does it sort of flat line from there? Or do you have an ability to continue to roll down the glide path, move to a more conservative portfolio? Our view is we are, you know, we know that the longevity revolution in the United States generally under saving situation, that participants need the growth assets in the early years. So we’re kind of a through glide path because if you’re not a through glide path you really … your risk around the retirement, the five years, you know, pre and post retirement actually kind of goes up because you’re moving down too aggressively. So in order to have the growth in the early years you need to have the through period so that as you sort of float through into retirement that you can manage that timing risk. The other thing is if you look at an investor at aged 65, in general you’re talking more than half are going to have a 15, maybe 20 year life expectancy. So they’re not short term investors at that point. So our approach is to sort of have a through but to have it well diversified across asset class, across different investment managers so that you can sort of balance the risk and reward, because behavior, you know, is definitely something that really influences the outcomes. It’s not just the investment returns; it’s whether people can stick with it.
And it, you know, and it works in both directions, you know, we’re sort of social, humans are social animals. So when things are going well you want to make you’re sort of in the game, in the market and you want to also make sure that when the market’s having tough periods that you don’t sort of … participants aren’t sort of scared out of their discipline of sticking with the Target Date Fund.
Glen: [00:11:49] And that you know, I probably take a little different approach when it comes to, to versus through. When I think about a to Target Date Fund I disagree with the common definition of that’s when the glide path basically flat lines. In my opinion a to glide path or a to Target Date Fund really gives participants optionality, the option to take their money out of the Target Date Fund when they retire or the option to leave it in. A through glide path in my opinion is more about one behavior, which is leave the money invested to continue to grow or to take some kind of systematic withdrawals. So if I were to redefine to versus through, I would say a to fund is managing that risk more at retirement, a through fund generally has more risk in the way that I look at Target Date Funds.
Courtney: [00:12:36] Rich, I’d like to get your take on to versus through.
Rich: [00:12:38] There are basically two religions if you will in glide path construction, the “to” versus “through” dichotomy. The key difference between them can be summed up in their landing point. So the point at which they reach, the glide path reaches its minimum risk posture or minimum equity exposure. The “to” approaches reach their minimum equity exposure and risk posture at retirement date. The “through” glide path designs continue to de-risk post retirement date and reach their minimum risk posture at some point in the future, presumably at ages 70, 80 or 90. The theory and the justification for the “to” approach which is the approach American Century espouses is that retirement date in financial terms is the riskiest day in your life. You have the biggest pot of money which you’ve built up and it has to now last you over your entire retirement horizon span throughout distribution mode. And so as you reach that maximum wealth accumulation you are by definition at your most risk intolerant. And so we adjust the glide path so that in the years leading up to and then hitting retirement you hit your minimum risk posture, so the time at which you can least afford to experience a dramatic hit to your financial wealth.
Courtney: [00:14:10] Rich, what factors should be considered when evaluating active versus passive Target Date Funds?
Rich: [00:14:16] Well, passive Target Date Fund investing has been growing; I think it now amounts to roughly a third of the assets in Target Date Funds. But I think first and foremost it’s important to recognize that there is technically speaking no such thing as a purely passive Target Date Fund provider. The glide path of a de-risking process is by its very nature an active decision. There is no benchmark or index for a glide path such as the S&P 500 is for equity managers. And so the biggest driver in Target Date Fund returns, the major determinant of the differences among Target Date Fund providers is the glide path, the asset allocation process. And that is very much an active decision. And so it’s important to recognize that if you do choose a passive Target Date Fund provider you are in essence giving them the important active decision of how to drive the glide path. Now, with that aside, a number of other points about passive investing in Target Dates, certainly it’s primarily driven in many cases by the search for or the desire for low fees, whether the returns are better or not again is going to be driven largely by the glide path design, which is an active decision. Importantly, with passive Target Date Fund investing, there are additional risks to that approach.
First and foremost there are certain asset classes that passive or index Target Date Fund providers just don’t offer because they cannot be effectively indexed or they cannot be effectively indexed at a low fee level. And so you are reducing your diversification, you’re potentially increasing your risk by going with an index provider. Secondly, and perhaps more importantly and more insidiously the level of risk control in passive Target Date Fund is lacking at the sub asset class level. Whether we’re talking about growth versus value stocks or emerging market equities versus developed market equities, these weightings or allocations are static over the lifetime, there’s no relationship to age or risk tolerance. And so whether you’re a 25 year old investor or a 75 year old investor you’re going to get the same exposure to emerging market equities, to growth versus value equities, to high yield bonds versus diversified or high credit quality bonds regardless. So the level of risk exposure at the sub asset class level is missing in index providers. That’s one of the things you’re giving up. And we feel at American Century it’s something that is key in Target Date Fund investing and a very important parameter to keep an eye on. We reduce our emerging market equity exposure as one increases their wealth in ages, as you’d expect. So that in retirement you’re minimizing that kind of risk exposure, similarly our glide path takes into account that we’re moving from growth equities to more stable dividend paying value equities as you approach and reach retirement. This type of active sub asset class risk control is not evident in Target Date Fund investing that’s passive.
Courtney: [00:17:43] Bruce, when you look at active versus passive Target Date Funds, what do you see?
Bruce: [00:17:48] Well, I think the market as it stands now, the good news is you don’t have to really choose one or the other. So as plan sponsors and participants, you know, think about what makes a good Target Date Fund, one of the things they should look at is, is active versus passive. And do they really think you have to be one or the other. So our approach is really to use both. Passive can be very helpful in keeping costs down and giving a nice consistent exposure to an asset class as a portfolio manager, it helps to, you know, manage portfolios. But you know, active managers, you can find managers in different categories that you might not necessarily even get exposure to in passive areas. And also there’s the element of should Target Date Funds have an element of dynamic allocation. And a passive is generally something where you’re not going to get that. And really when deciding on a Target Date Fund you should sort of think about, do you want to have the right amount of dynamic allocation, not too much, not too little, as investment professionals you can’t really ignore what’s going on in the markets, the risks and the opportunities in the markets. And as investment professionals we should be making adjustments. We also want to do it in a way that’s supportive of the consistency of the Target Date Funds because we think the consistency is really what drives long term outcomes.
Courtney: [00:19:01] Glen, can you give us your take on active versus passive?
Glen: [00:19:03] Yeah. And I agree with what Bruce is saying. And when I think about active versus passive as it relates to Target Date Funds, all Target Date Funds are active, meaning that there’s some kind of active management going on in terms of the underlying asset allocation and glide path that’s going on. And then you look at the underlying funds. Are the underlying funds active or passive? And there I think it depends. There’s definitely proven, you know, asset classes where active makes sense, where you can mitigate risk, mitigate especially downside. And I think our industry is getting so carried away with getting the cheapest fund at any price, they forget about the actual goal and objective of the fund. And the goal is to get us to that retirement nest egg and have retirement income, not to have the cheapest product on the market. And I think by this hyper focus on getting cheap product we can sometimes not reach our actual retirement goals.
Courtney: [00:19:59] Rich, how do you effectively benchmark or monitor Target Date Funds?
Rich: [00:20:02] Benchmarking in Target Date Funds is still an evolving science. I think consultants, plan sponsors, providers are all wrestling with the right metrics in benchmarks. Ideally you’d want to measure the effectiveness of the overall asset allocation decision or the glide path. You’d want to measure the effectiveness of the diversification, breadth and depth. And then also you’d want to measure the effectiveness of the underlying individual issue selection, stocks or bonds. And so you need benchmarks for all three of those key elements in Target Date Fund investing. Now, unfortunately we don’t have well established indices or benchmarks as such. There are a number of competitive benchmarks out there from Dow Jones, Morning Star, S&P Target Date Fund indices. And these represent a good start for basic benchmarking but they don’t get to the finer points of benchmarking such as the issue selection issue. So at American Century we not only use the more common competitive benchmarks, but we also have a series of custom benchmarks where we can get a finer distinction of measurement of whether we’re adding or detracting value in issue selection, in diversification and in glide path management.
Courtney: [00:21:24] Glen, how has the focus on outcomes really changed the way that Target Date Funds are monitored?
Glen: [00:21:28] Well, you know, when I think about Target Date Funds, if I were to compare them to a baseball game, I would say we’re probably in inning three of a nine inning game in terms of their development. And where they’re going next is all about outcomes versus performance and fees, so. And when you think about an outcome, well, what is an outcome for a Target Date Fund? It’s getting you to a predictable and reliable retirement income. So an example would be if I’m 63 or 64 years old and I’m going to retire next year, I’m going to have to have lived on a pretty tight budget and I’m going to need to know within a pretty narrow range what is my income going to be. So if my projected income is $20,000, I probably want my best case and worst case scenarios to be right around that $20,000, maybe 21,000, maybe 19,000, not 30,000 or 10. So I can budget effectively. So as we get closer to and better at managing Target Date Funds and managing toward outcomes, it’s going to be more about the reliability of that future income that’s going to be the most important.
Courtney: [00:22:35] Rich, why might a customized Target Date Fund not be optimal for a plan?
Rich: [00:22:40] Customized Target Date Funds, you know, have been talked about a lot over the last several years and they’ve been offered. But I think it’s important to recognize that in the (inaudible) and the mutual fund arena there are roughly three dozen or more Target Date Fund providers with lengthy track records and lots of experience and broad expertise in their teams managing these funds. And these different Target Date Fund providers in mutual funds, the so called off the shelf versions as opposed to customized, span a wide variety of glide path design, diversification, passive versus active, underlying issue selection etc. So I’m hard put to understand why a customized approach might be needed when you have so much variety out there in established, experienced expert mutual fund providers. Now, with that said, there are plans that perhaps have demographics where they desire a customized approach and that’s fine. The sponsor of course needs to recognize the extra time, effort and fiduciary responsibility or liability they take on when implementing a customized program. And perhaps last but not least it’s important also to understand that customized does not mean individualized. Every participant in a plan doesn’t get their own individual glide path in a customized approach. You have to customize to a specific participant or demographic average. And so much like with mutual fund Target Date Fund providers, you’re picking an average to hopefully hit the broad base of plan demographics. And again we’d argue that there’s such a wide variety out there, the need for customization is probably overblown.
Courtney: [00:24:43] Bruce, plan sponsors, they have to look past their short term nature of performance to the long term nature inherently of Target Date Funds, what should they be considering?
Bruce: [00:24:52] The good news is as Target Date Funds have gotten large, they’ve become, there are, you know, estimates that will 85% of new flows, maybe that’s a little high but, you know, there are a lot. And the balances as a proportion of plans are large, the individual participant balances are large, I think it is triggering between that and some of the tips from, say [unclear 00:25:14] tips of 2013 and the regulatory guidance, the good news is we’ve gone beyond just looking at short term performance, you know, these are long term. If anything’s a long term investment it’s a Target Date Fund, it’s a whole lifecycle, you’ve got years and years. You certainly need to monitor performance. But you know, making a decision off a short term performance just doesn’t make sense. You know, there had been a period where it was just sort of based on brand. We’ve gotten to the point where it’s become much more institutionalized. So things to look at would be if you wanted to sort of think of a checklist, there is how much asset class diversification? How many distinct asset classes you have? Over time, asset class diversification will help make for a smoother ride which generally will help to keep people engaged in the Target Date Fund. So that’s something you want to look at. You do want to have a view on what do you think about active versus passive, active, passive or a mix, that’s mostly what I’m talking about, the underlying assets, the security selection, traditional active/passive.
Other questions would be, is it multi manager? So some of the tips that we’ve gotten would be considered non-proprietary, so as these Target Date Funds have become large, they really have become sort of the plan within a plan, they take on characteristics, a well run Target Date Fund takes on characteristics of a traditional DB plan where you’ve got specialized managers in a particular asset class. You might have multiple managers. You might have a mix of active and passive. So you know, is there a multi manager approach? There is always firm risk, you know, we’ve seen high profile issues where large firms have had, you know, personnel issues. There’s also what is sort of overlooked is this sort of idea of groupthink. So as your Target Date Fund is a CIO, deciding what the tilt is going to be on an asset class and then that filters down to what the sector allocations are for the underlying managers and in the industry. The next thing you know you could have a Target Date Fund where asset allocations are all tilted in one direction. And that can either blow you up or it could … it might work in the long run, but along the way you could actually be out of favor to say in the wilderness. And then once again you’re forcing plan sponsors and participants to make that tough decision where, okay, my, you know then you go back to deciding on short term performance. So those are factors too.
Obviously the team in a firm, has it been stable, is it the same group of people that had built the structure based on the philosophy, so on and so forth? So those, you know, mixing performance with some of these qualitative factors, actually you can create a bit of a checklist that’s not necessarily going to answer the question for you but at least it gets you past just looking at the last, you know, three year performance.
Glen: [00:27:47] I’ll tell you, just when you, Bruce, when you brought up groupthink, it reminded me back when I was at a different company back in the 90s and I was in a 401K plan, and I got to experience, the negative side of groupthink. And it went something like this, so I was saving the way I was supposed to, I was allocating the way I was supposed to, but this particular fund family that I was with in my 401K plan, made a top down call to go overweight technologies. I don’t know if you remember what technologies were like in the 90s but they were…
Bruce: [00:28:17] It was great, [unclear 00:28:18].
Glen: [00:28:18] Yeah, I said that wrong, they weren’t overweight, I’m sorry, I got it completely wrong, they were underweight technologies so I did not benefit in this great, you know, technology boom in my 401K plan. So I was a little depressed because my balances weren’t the same as people my age. But then this fund company came out and said, “You know what, we got it wrong.” And they came out in February of 2000 and said, “We got it wrong and we’re going to overweight technology across the board.” So even though I was allocated correctly between large cap, small cap, international, I did not get the upside. But then when the technology bubble burst the following month I got all the downside. So that, I’m a real life living person of the negative effects of groupthink and why that’s a bad thing and why multi manager approach is a good thing.
Courtney: [00:29:06] Right. And, Bruce, I want to circle back, you mentioned the DOL’s tips publication for plan sponsors, how has that changed the landscape?
Bruce: [00:29:14] Well, I do think it has prompted this idea where, you know, just going from simple, you know, formulas, you know, rules of thumb whether it be performance or using the proprietary offering from the record keeper that you may have. There’s nothing wrong with that, certainly we’re a record keeper and we think our Target Date Funds are strong. But we also offer other Target Date Funds on our own platform. So we have to go out there and we have to compete head to head and make the case that, you know, the way we do it is best. So there has been a little bit more of an attention between the tips and just the size, I really think size has a lot to do with this. These things have gotten large. You wouldn’t necessarily want your DC plan with all one firm, maybe there are some people do that. But most people aren’t doing that now, so, or a DB plan. So there has been a review of, okay, you know, what’s the strategy? Who are the people putting in place? How diversified things are? What’s their philosophy around the entire lifecycle? What’s their philosophy in getting you to outcomes? So I really think those have been key tips. There has been a little bit of an element of just generally all types of asset allocation products have gotten attention. So in some markets, custom has gotten some attention. But off the shelf Target Date Funds are still very popular because people like the mutual fund structure. They like the fact that the fiduciary advisors are fiduciary to the [unclear 00:30:37] fund. And it’s just a, you know, it’s a relatively easy concept for people to understand. But it really has gotten people to start to look at a multifactor approach to making their decisions.
Courtney: [00:30:50] And, Rich, do Target Date Funds have any advantages over other investment options for a planned security IA?
Rich: [00:30:56] I don’t think there’s any question that Target Date Fund providers represent a prudent, efficient and very effective investment vehicle, as a QDIA, for many if not most plan participants who don’t otherwise have the time, the inclination or the expertise to do their own investing. From an investment perspective, they’re prudently managed, they’re actively managed both at the asset allocation and individual issues selection levels. And they’ve produced excellent results since they’ve been in place for the last 10 or 20 years, and certainly as a QDIA for the last seven years or so. From a legal and regulatory perspective the DOL paved the way for the QDIA or Target Date Funds as a QDIA back in 2006/2007. And so the fiduciary liability is minimized. And then last but not least, the real world stats show that Target Date Funds have been wildly successful and have broad appeal and certainly that explains their explosive growth over the last several years. And the abandonment rates are very low. The participant rates are very high. And the growth rate in the industry, not only for American Century but the industry as a whole has been extraordinarily rapid because they have been a successful qualified default investment alternative for most plans.
Glen: [00:32:26] Yeah, I think Target Date Funds, they’re obviously the most widely used QDIA out there. And I think the reason they are is really two or threefold. Number one, they’re the easiest to understand. All you have to do is pick the year you want to retire and you’re done. Now, they get some criticism, saying, “Well, they’re too simplistic and whatnot.” But when you look at how participants fair inside of a Target Date Fund versus them doing it on their own, they generally do 200-300 basis points better performance in a Target Date Fund. So it’s a huge, huge step forward in terms of doing the right thing and getting a better return on your investment going forward. So they’re very good. The other QDIAs, you know, if I look at them one by one, you look at a target risk fund, target risk funds are good but the problem is with a target risk fund from a behavioral finance standpoint is that participants don’t go back and make changes as they get older. So an example would be if I’m 20 years old and I go into the aggressive risk fund, and I age and now I’m 40 or 50 years old, I probably didn’t go back and change my allocation from an aggressive fund to the moderate fund, to the conservative fund. So that’s inertia, people just don’t go back and make changes. So Target Date Funds take care of that for you. The other QDIA is a managed account, a little more … you need a little more interaction with a managed account, you need to give input information, again, participants don’t like going online and filling out information and putting more financial information in and they cost more too. So right now I think there’s more time consideration needed for a managed account and there’s a little more expenses incurred in them.
Courtney: [00:34:13] Bruce, do you concur?
Bruce: [00:34:14] Yeah, I would concur with that. I think, you know, generally it’s always compared to what? So it’s really … what we’re comparing it to is what most investors were doing before. And we’ve heard stories about what, you know, firms investment professionals did as far as you know, you know, making that tech call that you mentioned. But individuals were doing the same thing, they were, you know, they were getting out of their balanced accounts and going into tech funds in 2000, so on and so forth. So generally these … any type of multi asset QDIA, whether it’s a managed account, a custom target or off the shelf target or a target risk, those are generally better than what most people were doing. Target Dates just seem to work from a behavioral perspective. And that really is, if you look at say the Dow Bar studies of what people do when they do things on their own, there’s a huge gap in performance relative to the market return versus the investor dollar returns. And some of that’s fees but the vast majority of that is their actions. And so Target Date Funds turn that inertia into a positive thing.
Courtney: [00:35:15] Glen, and are there any negatives in showing projected income on participant statements?
Glen: [00:35:20] Well, yes, but to be clear I think showing projected income on participant statements is a very good thing. And that’s where the industry should move. And as the industry continues to move, there are now a lot of record keepers are already doing that. But the problem is if you are a participant and you look at that projected income, you’re probably expecting that’s going to be the income when you retire. So the problem is or the risk could be that that income could have a huge amount of variation if you will. So as we get better as an industry we want to make sure we tighten up that range of outcomes that can happen. So if you’re shown a projected income of let’s say $20,000, you can be relatively sure as a participant, that that will be about what you get. And there’s not going to be surprises, especially on the downside where your $20,000 is now 13,000 or 10,000 because that’s going to blow up your budget.
Courtney: [00:36:13] Rich, what plan design elements are important for participant outcomes?
Rich: [00:36:17] Well, as far as plan design elements, I think that no one can overemphasize communication whether it’s oral or written or electronic, communicating with participants, emphasizing their contribution rates to a 401K or a defined contribution plan is essential. No Target Date Fund or for that matter, no investment strategy can be successful unless the participant or the investor is actively engaged and contributing a healthy savings rate to their own retirement success. With that said, as far as plan design goes, the trend is clearly in the direction of rebooting plans, installing Target Date Funds as the qualified default investment alternative and then also auto enrollment and auto escalation, these are the design elements that are successful and not only successful but in the best interests of the investors, of the participants, of the plan sponsors themselves. Again, the bottom line when it comes to plan design, the best conceived plan designs, the best conceived Target Date Funds or investment vehicles are not going to be successful without healthy participation from the participants themselves, so it’s the savings rate more than anything that determines a participant’s success or failure in retirement.
Courtney: [00:37:48] Glen, how can dynamic risk management bridge the gap between risk and required returns?
Glen: [00:37:54] Well, that’s a good question because most Target Date Funds are managed, trying to get the most return for the amount of risk taken. And what we’re finding is that many participants just cannot stomach the risk that’s going on. So by having some kind of dynamic risk management overlay, what you can do is preserve most of that upside return that you need to actually … to hit your retirement goals and minimize that downside. So to a participant, especially one that’s getting close to retirement, if you can mitigate and buffer that downside, they’re going to stay with the program and they’re going to realize the returns they need to hit their income goals.
Courtney: [00:38:34] Bruce, do you think dynamic risk management can bridge the gap between risk and expected returns?
Bruce: [00:38:40] Well, I think it can help, it is something where, you know, as an industry, there’s sort of a zero sum game, so you know, there’s only so much you can do. But I do think that, you know, at some point we will be staring in the face of higher interest rates. We haven’t got it yet, it’s been longer than anybody expected. But that has to be one of those things, at some point, you know, what’s risky and what’s not risky is going to require a little bit of adjustment to just having a simple basic equity fixed, and one is risk and one is not. So those type of questions and adjustments are going to be something that potentially could add a lot to making the experience of participants a lot more positive and keeping them in the discipline of their Target Date Funds.
Courtney: [00:39:28] Rich, do you concur?
Rich: [00:39:29] Dynamic risk management and in its prior form, tactical asset management could potentially add value or diminish risk in a Target Date Fund environment. On the other hand, that type of risk management, I think it’s a misnomer, could also add to the risk level in a Target Date Fund glide path and to investors. An inappropriate adjustment to a glide path at the wrong time has the potential to not only diminish return but also add to risk. At American Century we hold the glide path essentially sacrosanct. We do not make tactical calls. We do not make so called dynamic risk adjustments to the glide path, because again there’s always the potential to make the wrong call and that would be true for anyone. And that risk in our estimation is just not worth it, especially as one nears and hits retirement, where the tolerance for risk is so low and the penalty for being wrong in an asset allocation move, tactical or otherwise is so huge.
Courtney: [00:40:39] So a common criticism of Target Date Funds is that they’re a one size fits all approach. Bruce, how would you respond to that?
Bruce: [00:40:45] Well, I think, you know, that is actually part of the charm of Target Date Funds. You know, the design, certainly when we sit down and we look in the industry, we sat down designing ours, you know, most folks are in a similar situation, you know, longevity is something that is on average going to be a big issue. And even if you’re … unfortunately you don’t experience that, you certainly have to plan for it, you’re not necessarily going to plan for the alternative. So that’s a reality, the savings situation is generally pretty broad based across the country and across the industry. So there are some common factors that are very pertinent to designing Target Date Funds. So that’s, you know, that’s the simple part. There is something where if you have a very specific situation, Target Date Funds are still generally going to be better than most alternatives, what people are doing. We certainly believe that people have unique situations, there are different types of Target Date Funds. You can, if you have a demographic population you can adjust for or clearly if people have very specific situations, we certainly would recommend booking a financial planner. Use a Target Date Fund maybe as part of a tool or a wider plan, but you know, get specific guidance. So for most folks, having something that’s a very common approach is going to work better. There’s always going to be a few differences. But for the most part, you know, we haven’t seen too much of that. And when we do, people know how to adjust for it.
Glen: [00:42:23] Yeah, I tend to agree and I disagree with that criticism that one size fits all is a bad thing because again, I’m going to go back to, we’re going through an evolution here. We’ve just got final QDIA regulations in 2008. And since then and since we’ve started putting folks into Target Date Funds, their performance has gone up anywhere from 2-3% per year. So that’s hard to criticize, that you’ve helped so many people that have been in Target Date Funds. And again I’m going to compare them to a baseball game. We’re in inning three of a nine inning game. You can’t criticize a baseball game because it’s in inning three and you want to be in inning nine. You’ve got to go through each inning and that’s what we’re doing. We’re going through the evolution of Target Date Funds. And as time goes on they’ll continue to evolve and become more specific. Over in Europe we already have Target Date Funds that are customized at the participant level. We’re just not doing that in the United States yet but it will come. And so again you can’t really criticize evolution, it will take its time and course as technology gets better, as we get better regulations.
Rich: [00:43:25] And one thing you do have to consider is as you customize things you get back to the complexity. So even though it might on paper from an investment perspective or even from a financial planning perspective, be a better fit. If it gets them out of this situation where they stick with it then it might not be worth it. So that’s the balance, so you always have to consider that and it’s not something you’d do without going through the thought process in a disciplined manner. But you know, there’s a lot of benefits to having a, you know, one size fits all because everybody’s in the same boat and you don’t go to the situation where you’re having to … chasing whatever the hot dot is because you know, everyone’s in the same boat.
Courtney: [00:44:04] And if we’re in the third inning here in the US, what inning are we in, in Europe?
Glen: [00:44:08] I’d say in Europe we’re probably in inning five or six. Again, just because they’ve … and it depends on what country we’re talking. But in The Netherlands we have some clients that are doing Target Date Funds and we literally have an LDI approach within the Target Fund at the participant level. So they can literally lock in their income five or ten years in advance of retiring and not have any … virtually no variation of what an income’s going to be and no surprises. So that’s where we want to go, is get to a point where there’s no surprises. So I think of it as a defined benefit plan. You look at a defined benefit plan, if you’re a participant you know exactly what you are going to get in terms of monthly income to the penny. At some point we’re going to be there, here with Target Date Funds and with DC plans.
Courtney: [00:44:57] Rich, a common criticism of Target Date Funds is that they’re a one size fits all approach, how do you respond to that?
Rich: [00:45:03] You know, the one size fits all approach criticism that’s lobbed over Target Date Funds, it’s also used against mutual funds in general. I mean all investment strategies in some sense are one size fits all. It’s of course up to the investor at some point to determine whether it should represent their entire investment strategy or whether it should be used in combination with other elements that would better tailor it to their unique circumstances. But with that said, Target Date Funds are anything but one size fits all. In fact because they are a series of vintages over time that are matched to the investor’s age or retirement date or wealth profile, they are actively managed in keeping with an individual’s risk tolerance over a lifetime. And so they’re one size fits all but they’re dynamically managed to well fit if you will, an investor over their lifetime. And clearly represent an enhancement to the way it used to be done in most defined contribution plans. So until we can discover some better approach than a Target Date Fund I think these are the appropriate default vehicles in defined contribution plans for the foreseeable future.
Courtney: [00:46:25] Bruce, can you comment on the current market environment and how it applies to you managing Target Date Funds?
Bruce: [00:46:30] Yes. You know we are at a point right now where, you know, the market’s in flux maybe even more than normal. It’s always in some sort of flux. You know we have a situation where energy prices have come in dramatically, inflation expectations have come in quite a bit. Those types of things, you know, falling energy prices, generally in the long run is good for the market. The global growth in general is going to be positively affected, certainly developed countries like the United States, Europe, so on, and so those areas will generally be affected positively, kind of like a big tax cut. It also helps consumer sentiment which is another driver. So that’s, you know, that’s the big positive out there. We also have a situation where Europe has taken some actions with their QE. The fact that inflation has come in has allowed a number of countries to start cutting interest rates, emerging markets and some of the commodity sensitive countries like Australia, so on and so forth. So those types of things, you know, generally should be positives. But we are, you know, looking at the impact of the fall in inflation expectations on, you know, what’s the impact of Europe on growth, credit situation? So you know, if we can get past those things, there’s certainly a pretty good bull case.
From our perspective, you know, we do have dynamic allocation as part of what we do, but it’s really not meant to be the main driver because we want that nice consistent approach where people can know what they’re getting, the glide path, so on and so forth. For us what it means is, you know, we will make adjustments as we sort of see what’s going on. The big question right now is obviously interest rates. So in that environment the low inflation expectations, lower commodity prices, low inflation means The Fed could be on hold for longer than people expected. By the same token we’ve got some pretty strong job numbers in the United States. And I think The Fed wants to sort of get off the zero bond on interest rates. So that’s sort of the big, you know, the push and pull right now. The big question is obviously interest rates. And so what happens there is something. So what we will do is we do make adjustments, we will, you know, tilt things like our duration back and forth to help mitigate if they were to have a dramatic increase in interest rates to try to, you know, mitigate some of that impact. And once again the key is to, you know, adjust a little bit according to where the risk and opportunities are. But what we don’t want is whether it be groupthink or those top down decisions to sort of get any … get the Target Date Fund off track. We want to stay on track and just make adjustments, you know, accordingly. You know you can’t ignore the markets but you also don’t want to make it something that dominates the performance of the Target Date Funds.
Courtney: [00:49:10] And, Rich, what are you seeing in this current market environment and how does it impact how you’re managing Target Date Funds?
Rich: [00:49:15] Well, we’re an active investment manager at American Century. That’s all we do. And so obviously the current economic environment, the current valuation measures, current investors sentiment, all of these elements come into play as we’re managing our stock and bond and alternative asset portfolios. So for example with the likelihood, if not high probability, of higher interest rates to come later this year, our fixed income portfolios are smartly positioned with a slightly shorter duration or average maturity, to protect our investors especially at retirement from the harmful effects of higher interest rates which eat into retirement income, or even higher inflation. And so we also have a healthy amount of inflation protection assets in our in-retirement portfolio. So the current economic environment comes into play in a number of ways across virtually all of our investment strategies underlying the Target Date Funds.
Courtney: [00:50:20] And, Bruce, I want to come back, when you’re looking with what you said, with what you’re seeing in the market, how does that impact say a 2020 fund versus a 2050 fund?
Bruce: [00:50:27] You know, generally it’s going to have a similar impact. You know, we run the portfolios pretty similar across the board. The 2020 fund, well, they will be something where we pay a little more attention to interest rates just because there’s more interest rate risk embedded in that portfolio. So it will have a slightly, you know, our decisions, they will have a slightly bigger impact on something like our 2020 fund or our 2010 fund than it would our 2050 fund just because of where it is in the glide path. But you know, directionally we’re generally going to, you know, if we have an opinion then it’s going to flow through all the portfolios.
Courtney: [00:51:07] And, Glen, what will Target Date Funds look like five years from now?
Glen: [00:51:10] Yeah. You know, no one has the crystal ball per se. But what I think they’re going to look like five years from now is they’re going to get more and more customized, if you will, at the participant level. So right now, yes, because you select the Target Date Fund that’s right for a particular plan sponsor, a particular cohort if you will, that might be a 1,000 employees or 10,000 employees. But as time goes on they’re going to evolve and be more individualized. And there’s going to be a much, much greater emphasis placed on being able to have reliable income and predictable income. And that shift is going to occur. So it’s no longer going to be about who has the best return on your Target Date Fund, it’s going to be about who can you give the greatest amount of reliability of that income that you’re going to need at retirement, and the focus is going to be on that, and trying to really narrow down that range of outcomes that can occur.
Courtney: [00:52:06] Bruce, where do you see Target Date Funds in five years?
Bruce: [00:52:08] So, I think, you know, I take a slightly different tact in the sense that a lot of times change comes very, very slowly, slower than you think, and then all of a sudden it comes fast. So you know, probably five years from now we’ll still be talking about finding ways to really solve getting true income into a retirement plan or a Target Date Fund, building package products somehow. So I think we’ll … that will be a … will be a lot of fast and furious innovation and work around that. I don’t know that the market will actually be there. But that’s kind of where the conversations will be. I do think that, you know, it’ll probably look a lot like it does today, you know, either … so the 80/20 rule, the top four or five firms have a lot of the market share. And having said that I think it will … features of DB plans will more and more find their way into the Target Date Funds as people, you know, consider that a good way of running their portfolios but also as the market demands it. And so I think you’ll see some of those features, multi manager, multiple asset classes, those types of things, more of an outcome, income oriented approach, will all be in there. I don’t think we’ll have it all tied into a bow unfortunately in five years and put it all together. But I think we’ll be making progress and I think we already are making some progress and I’m looking forward to it.
Glen: [00:53:32] Yeah. I like, Bruce, what you said about DB plans. And I think it might be more than five years, but at some point in the future I think we’ll look at the fund contribution plans and Target Date Funds and there’ll be an asterisk. And it’ll say basically plans morph from a DB plan or everything was done for you by your employer, even the funding. And the DC plan will look just like that DB plan in terms of how we treat participants except for it being a 100% employer funded, it’ll still be largely employee funded. But they’ll look a lot like the old DB plans. That’s where we’re headed in the future. I don’t think we’ll get there in five years, but I think that’s what the future looks like.
Courtney: [00:54:10] Rich, where do you see Target Date Funds in five years?
Rich: [00:54:13] Well, there are a number of items on the docket for Target Date improvements. I think as far as the glide paths go, they may not look dramatically different five years down the road than they do today, perhaps there’ll be some additions in terms of broader asset classes as liquid alts come on stream and the costs are reduced and they become a more viable investment vehicle for institutional investing. But I think where the real changes are going to be evident are in the post retirement portion of Target Date Funds. The recent proclamations by the government to allow or at least give a safe harbor to annuities – deferred annuities into Target Date plans, this was a big breakthrough. And this is probably, you know, a harbinger or a canary in the tunnel if you will, for where things are going. More outcome oriented in-retirement structures embedded into Target Date Funds. So it’s the post retirement optimization that I think we’re all seeking the Holy Grail for.
Courtney: [00:55:22] And I want to ask you guys, is there anything a retail advisor or investor should know about Target Date Funds that you think they don’t already know, Glen?
Glen: [00:55:31] Yeah, I think so because I think a retail advisor needs to know what the goal of the Target Date Fund is for their retail clients. So for instance, if you’re my client and you’re my retail client I want to know what the name of the Target Date Fund that you’re in and what the goal of that Target Date Fund is and what the assumed behavior that they’re assuming you’re going to exhibit. Are they assuming you’re going to take the money out of the Target Date Fund when you retire and work with me, your financial advisor? Or are they assuming that you’re going to leave the money in your Target Date Fund and take income from that Target Date Fund? Because that’s going to change how I’m going to work with you and how I’m going to advise you. So if I’m a retail advisor I want to know the goals and objectives of the Target Date Fund for my clients.
Bruce: [00:56:21] I would agree and I would sort of elaborate a little bit in the sense of going, you know, what you hope to see is not a repeat of the sort of bad behavior of the old days of just chasing performance and that, you know, you can do it with Target Date Funds too. It’s a lot of work to, you know, we’ll take your Target Date Funds out every couple or few years, but you know it’s possible. So I think the idea of going beyond sort of performance, going to sort of a multi factor checklist is key, that the goals of the Target Date Funds and what their assumptions are. And then also, you know, hopefully going a little bit more into depth on the philosophy of the actual mechanics, you know, sort of how they think about the market, so that part. So I think between knowing sort of what the goals are and knowing how they implement those, hopefully you know, that’s something that is out there. And it doesn’t require, you know, a ton of extra work. There are some checklists you can just sort of go through. And at least you should, you know, acknowledge, okay, passive/active, those things we talked about already. And you know there are tools out there to help do that. And I think we’re starting to see certainly some of the back office folks and various advisors and brokers, implement some of these, I call it tool.
Courtney: [00:57:35] And, Rich, anything you want to add about what advisors should know about Target Date Funds?
Rich: [00:57:39] Well, I think a lot is out there on Target Date Fund strategy and usage. But perhaps one of the subtleties that’s not as well known at the retail level is, you know, in a defined contribution plan you’re typically defaulted into the vintage of a Target Date series which is aligned closest to your retirement date, presumably aged 65 or 67. However, it’s important to understand that that’s not necessarily the best or most appropriate choice, depending on other assets an investor or participant may have outside of the defined contribution plan in question, or perhaps taking into account how well or how poorly that participant has saved over their lifetime. So there are other elements about the individual which are relevant and should be taken into account before one just naively places an investor or a client into a Target Date Fund that is simply matched to their age.
Courtney: [00:58:44] Did you want to add something, Glen?
Glen: [00:58:44] Yeah, I would add one more thing, an easy kind of check point might be for an advisor is just look at the percent of equity in that Target Date Fund at the target year of retirement. So for example, does that Target Date Fund have 60% equity at retirement date or does it have 25% equity? Because our Target Date Funds have both of those. And you will need to know that if you’re the advisors that, you know, how much equity because that’s going to help you manage the rest of the portfolio and how to manage that potential rollover is knowing the percent of equity and how much risk they’re already taking.
Courtney: [00:59:14] That’s a huge disparity too.
Glen: [00:59:16] Huge disparity.
Bruce: [00:59:17] And obviously we come at it from different angles. You can sort of guess who’s 25 and who’s 50. And the good news is … well, some advisors want the 50, some want the 25s. So once again does it fit with your view of the world? That’s key.
Courtney: [00:59:32] Well, we’re coming near the end of our class and I’d like to get your final takeaways. Bruce, what are your final takeaways?
Bruce: [00:59:37] The takeaway that I would leave folks with is you really need to just go beyond the old days of just looking at performance. You need to think about how the portfolios will do along the way both up markets and down markets, both are very important to the investment results. But it’s really about getting to better outcomes through better behaviors and having portfolios that can be as much as possible, given the markets, all weather, that can hang in there and up markets hang in there, down markets to keep people invested in their Target Date Funds because Target Date Funds are just part of the solution, right. There’s enrollment, there’s auto escalate, there’s all those different features that can get us closer to something th