Moving Target with Target Date Funds
Target Date funds are the most frequently used Qualified Default Investment in a retirement plan, but they often all get lumped together when there are vast differences between offerings. Here’s an overview of what to know:
Multi-Manager or Single Manager?
Target Date funds can either be managed by one investment firm or by many. For the single manager funds, they’ll argue that all of their managers have a seat at the table and can make joint allocation decisions with their chief investment officer, eliminate unnecessary overlap or risk exposure, and have a cohesive investment philosophy. Multi-manager funds will argue they’re able to pick the best managers in the universe to fit each slot in the portfolio, that the overall allocation is still able to be designed with risk and investment philosophy overlays, and it allows for funds failing their mandates to be replaced easily.
Custom or Off-the-Shelf
You can choose a pre-made product as mentioned above, or in the multi-manager approach, you could customize this further by selecting your own glidepath manager, and then filling the target date fund with only the funds you offer in the rest of your plan’s core lineup.
Broader Diversification
Many target date funds have exposure to alternative asset classes, like hedge funds, commodities, global real estate, and certain types of bonds, which allows controlled exposure to these diversifiers. Making these available to all participants as individual fund choices in the core lineup could result in some pretty imprudent investing behavior. However, these asset classes generally have higher costs, so that could drag down performance if the manager isn’t careful.
Passive or Active Fund Management…or Both?
Target date funds boast both active versions, passive versions that use index funds only, or a combination of active and passive. (One thing to note… all target date funds are “active;” making an asset allocation decision is an active choice, whether you’re using active or passive underlying funds!) Active management may not suit everyone’s appetite, particularly for the fee conscious or those that do not believe managers can beat the market over the long term. However, it can be argued that risk-adjusted performance, or a “smoother ride” through downturns, might be worth paying extra. Still other target date funds use chunks of passively managed funds with some active sprinkled on top, usually labelled “hybrid” or “blend.”
Registered Funds and CITs
Collective Investment Trusts (CITs) are becoming more popular in order to drive down fees. However, it should be noted that these are trusts that are regulated at the state level, versus mutual funds registered at the SEC (federal) level. Some TDFs take advantage of the lower cost structure for the plan where available even though participants lose the ability to look up the ticker symbol and plan sponsors have to rely on proprietary reporting for research and monitoring purposes.
Fund of Funds or Portfolio of Securities?
Target Date funds are available as a fund made up of other underlying mutual funds, or they are available as a portfolio of underlying securities in CIT form. Fund of funds will argue that they’re using building blocks and have less securities related risks, more transparency due to the registration, and easy to understand allocation, whereas securities portfolios will argue they’re more cost effective, can react faster when changes need to be made, and have the advantage of being able to gauge risks down to the individual securities level. Alas, the participants will not be able to look them up using a ticker symbol and performance reporting has to come from the fund family.
Dynamic Versus Static
Many target date funds have a particular allocation and glidepath that they stick to. Others allow some plus or minus variance in asset categories based on the current environment. Short term shifts might allow managers to respond better to market conditions, or it might be a recipe for a bad call.
Risk + Time: Managed Accounts Meets TDFs
Some target date funds come in a variety of risk vintages — in other words, a plan sponsor could say that overall most of their employees have less risk appetite, and therefor they want the less aggressive version of the glidepath offered by a fund family. A newer trend is to incorporate a quiz that asks for other data points to design an individual glidepath, such as marital status, additional assets, DB plans, plan balance, risk tolerance, etc. Getting a participant to actually take the quiz and provide that information can be very problematic, however.
Our overall take away: it’s not as easy as “hey, let’s make our default investment a target date fund.” There are a lot of aspects to consider besides those the DOL suggests and Target Date funds and one of the most important investments to review as the market changes.
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