Jim Lauder rebuts RIABiz article on the failure of target date funds
By 2020, an estimated 70% of all assets in defined contribution plans could be in target date funds -- and that's a good thing, according to the author
Brooke’s Note: The growth of target date funds — currently at about a half trillion of assets — is both startling and worthy of reflection. Have advisors finally proved the importance of process over products only to be out-processed by a product? Robert Boslego ably and skeptically opened the conversation on July 22 with: Why target date funds fail in the one area they’re supposed to succeed — downside protection. It’s a tough act to follow, but Jim Lauder has risen to the task in a timely and thought-provoking manner in this rebuttal. I can only hope this counter-punch sparks more intellectual fireworks on what was until now a sleeper topic — perhaps from Mr. Boslego himself.
A recent article (7-22-13) here., “Why Target Date Funds Fail in One Area They’re Supposed to—Downside Protection,” caught my eye. What a headline. RIABiz editor Brooke Southall introduces the piece, written by a consultant, with a note on Nutrisystem and its mediocre results when it comes to people keeping off all the weight they lost on the program.
Actually, being compared with Nutrisystem isn’t so bad. Two-thirds of Americans are overweight or obese. Health issues associated with this staggering number account for 21% of our country’s annual health care costs. Nutrisystem combines balanced meals, behavior modification, education, and support to help improve the health of those who are unable to help themselves. A study of 100,000 Nutrisystem users, posted on the company’s website, showed that 79.4% of users lost at least 5% of their starting body weight—this is considered clinically meaningful. Not bad.
By 2020, an estimated 70% of all assets in defined-contribution plans could be in target date funds, according to unnamed speakers quoted at the 2013 NAPA/ASPPA 401(k) Summit quoted by AdvisorOne.com in “Measuring Risk in Target-Date Funds,” March 11, 2013.
Target date funds are increasingly the retirement plan product of choice because they can serve as the automatic default investment for companies’ 401(k) plans—also known as QDIAs (qualified default investment alternatives). We believe that they continue to hold the potential to do the greatest good for the greatest number of individuals.
Transparency and risk, the big disconnect
I absolutely agree with the author that more transparency and improved communications around potential risks of target date funds are good ideas. With so many investors selecting target date funds, we must make sure fiduciaries and plan participants are able to make informed choices and understand the risks associated with any of their investments. There is, as the author alludes, a big disconnect between how much risk financial advisors are willing to expose retirement plan participants to and the amount of risk taken in most target date funds.
Most investors are uncomfortable with even a 10% loss near retirement, but in 2008, most 2010 target date funds lost much more than that—even up to three times that. In 2008, the Morningstar target-date 2000-10 category average was down 22.46%. Among leading target date providers, 2010 target date fund losses ranged from 10.75% to 30.27% in 2008. While a 22.46% loss sounds bad, it is even worse when put it in dollar terms. Suppose you have a participant who has done everything right and has built up a $500,000 nest egg at retirement. If this participant had been invested in the average 2010 target date fund back in 2008, he would have experienced a $112,300 loss and seen his nest egg drop to $387,700. It is easy to understand why politicians, regulators, and the press started pointing fingers.
What’s really to blame?
However, it’s wrong to say that a retirement plan provider on either end of that spectrum did a poor job or failed those participants. For example, I believe that a few providers that had larger losses delivered performance absolutely in line with the target date philosophy they had communicated for years. Was the philosophy of taking above-average risk in an effort to mitigate longevity risk and lack of adequate retirement savings wrong? Not necessarily. Was that philosophy misunderstood by some fiduciaries and investors who experienced above-average 2008 losses? Absolutely.
Slap in the face to advisors
Likewise, saying the growth in target date funds is “largely attributable to ignorance,” is another slap in the face not only to individual investors but to the financial advisors and consultants who helped plan sponsors select their specific target date fund lineup in the first place. From firsthand experience working with some of the most competent and skilled advisors in the country, I can tell you that the decision-making process around target date funds has progressed tenfold from where it was when initial QDIA decisions were made in the wake of the Pension Protection Act of 2006.
Advisors advance evaluation process
Advisors are recognizing that traditional peer group evaluation, based solely on returns, is not stringent enough in this space. They are building robust metrics that focus on finding the right glide path based on how much risk fiduciaries are willing to expose their unique populations to. They value transparency and a manager’s belief (and dedication to) his or her particular philosophy. And they value appropriate risk-adjusted returns over market cycles rather than top-quartile absolute returns in a given quarter. Advisors and their plan sponsor clients deserve some credit in this respect.
Don’t blame participants
Claiming that target date funds are bad because they are misunderstood by investors is rather ridiculous. Do those participants who make their own decisions to invest their retirement plan assets in stocks versus bonds, growth versus value, or emerging markets versus developed markets have a greater understanding of asset allocation and risk mitigation than target date fund investors?
One of the main reasons target date funds were developed is because the industry and experts agree that attempting to move the needle on financial literacy is not as effective as providing a professionally managed diversified portfolio that reduces equity risk as participants near retirement. Do we really believe that individual investors will better understand the customized Vertical Risk Management solutions the author endorses? I don’t know. What I do know is that anyone who can effectively and consistently time the market to avoid a majority of the losses while being present on the upside is probably sitting in their swim trunks on a yacht somewhere earning two and twenty.
Regulators are not unhappy
The article also gives the impression that the Securities and Exchange Commission and Department of Labor have negative views of target date funds. As someone who was invited to testify before a joint hearing following the 2008 crash, I can tell you that is not the
case. Their recommendations to date have focused primarily on improving transparency and communications in a product space with a variety of product styles. This is no different from the efforts they make to improve transparency and communications with any retail investment.
I do agree that some of the recommendations will have little impact, but I continue to believe that more transparency in the industry as a whole is better than less.
The author brings up an idea similar to what we at Global Index Advisors proposed to the SEC/DOL in a response letter to the proposed disclosure rules, and that’s communicating investment risk in terms of the experience an investor may have. Maximum drawdowns and possible recovery periods for investors close to retirement is a great starting point. I agree that this is easier said than done.
Recipe for success
At the end of the day we all have to focus our attention on participant outcomes. No single investment solution will solve the retirement savings crisis all by itself. We need fiducially sound financial products delivered with the utmost objectivity, transparency and consistency. But target date funds are only the balanced meals in this equation. The real results come when we quit talking about whose food is better and realize that today’s retirement crisis requires a combination of balanced meals, behavior modification and education.
Jim Lauder is chief executive of Global Index Advisors, which subadvises the Wells Fargo Advantage Dow Jones Target Date FundsSM. He is co-manager of the Wells Fargo Advantage Dow Jones Target Date Funds.
The views expressed and any forward-looking statements are as of July 25, 2013, and are those of Jim Lauder, CEO of Global Index Advisors and co-manager of the Wells Fargo Advantage Dow Jones Target Date Funds and/or Wells Fargo Funds Management LLC. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the author and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Funds Management LLC disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.
“Dow Jones®” and “Dow Jones Target Date IndexesSM” are service marks of Dow Jones Trademark Holdings LLC (“Dow Jones”); have been licensed to CME Group Index Services (“CME Indexes”); and have been sublicensed for use for certain purposes by Global Index Advisors Inc., and Wells Fargo Funds Management LLC. The Wells Fargo Advantage Dow Jones Target Date Funds, based on the Dow Jones Target Date Indexes, are not sponsored, endorsed, sold or promoted by Dow Jones, CME Indexes or their respective affiliates, and none of them makes any representation regarding the advisability of investing in such product(s).
Wells Fargo Funds Management LLC, a wholly owned subsidiary of Wells Fargo & Co., provides investment advisory and administrative services for Wells Fargo Advantage Funds®. Other affiliates of Wells Fargo & Co. provide subadvisory and other services for the funds. The funds are distributed by Wells Fargo Funds Distributor LLC, Member FINRA/SIPC, an affiliate.
If only life were that simple. You can twist data to conclude you want:
Figures don’t lie but liars do figure.
With business, especially a young one, you have to, unfortunately, rely on people
with common sense, knowledge and the willingness to use them.
I’m not willing to trade the thoughts of Mssrs. Boslego, Lauder and Surz for what any robots with
spin artists have to say.
“The U.S. Securities and Exchange Commission’s Investor Advisory Committee adopted recommendations today asking the agency to rewrite its proposed rule on target-date retirement funds.
“The recommendations adopted by the committee at a meeting in Washington would expand a 2010 SEC proposal by requiring increased disclosures to investors in the funds about their fees and risks.
“’In making this change in disclosure, we are actually going to teach investors something really important that most of them don’t understand,” said James Glassman, a committee member and founding executive director of the George W. Bush Institute, said at the hearing. ‘There is more to risk than asset allocation.’”
“’The risks were not well understood by fund participants,’ said Barbara Roper, an advisory committee member and director of investor protection at the Washington- based Consumer Federation of America.”
Source: Target-Date Fund Rule Revisions Urged by SEC Advisory Committee, Bloomberg, April 11, 2013.
“On a survey commissioned by the SEC, only 36 percent of respondents (including 48 percent of target date fund owners and 26 percent of non-owners) correctly answered a true-false question regarding whether target date funds provide guaranteed income after retirement.”Recommendation of the Investor Advisory Committee Target Date Mutual Funds (Adopted April 11, 2013)
Elmer Rich III
If there is public information that is pro or con an investment decision by a fiduciary:
1. Are they required to do a search?
2. Are they required to include the information in the record of their process?
On financial education:
“In response to such consumer deficiencies, governments, employers, and financial institutions have begun to engage in financial education. Examples of education initiatives include paycheck stuffers, newsletters, summary plan descriptions, seminars, individual consultations with financial planners, and access to Internet-based education and planning tools…
Unfortunately, studies of the effectiveness of such interventions have revealed mixed results. Although some researchers have decisions, others have critiqued this work for use of nonrepresentative samples, for the researchers’ reliance on statements of intention rather than actual behavior, and because it confounds a firm’s provision of financial education with other factors that influence saving behavior, such as the level and structure of…”
from Subjective Knowledge in Consumer Financial Decisions – LIAT HADAR, et al ’13
The word “mixed” in research means no worthwhile results.
“Target date funds that were close to reaching their target date suffered significant losses in 2008, and there was a wide variation in returns among target date funds with the same target date. Investment losses for funds with a target date of 2010 averaged nearly 24% in 2008, ranging between approximately 9% and 41% (compared to losses for the Standard & Poor’s 500 Index (‘‘S&P 500’’), the Nasdaq Composite Index (‘‘Nasdaq Composite’’), and the Wilshire 5000 Total Market Index (‘‘Wilshire 5000’’) of approximately 37%, 41%, and 37%, respectively)”
Source: Security and Exchange Commission, Federal Register / Vol. 75, No. 120 / Wednesday, June 23, 2010 / Proposed Rules, page 35921.
• “More than half of all respondents (54%) failed to correctly indicate that TDFs with the same year in their names do not necessarily have the same mix of stocks and bonds at the target date.”
• “Only 9% of all respondents correctly answered that none of a series of statements about similarities among TDFs with the same target date were true; 50% incorrectly answered that the mix of investments of two 2020 target date retirement funds reaches its most conservative point in 2020.”
• “Over 50% of TDF owners expected that a TDF’s stock allocation would be 40% or less at the target date.”
Source: “Investor Testing of Target Date Retirement Fund (TDF) Comprehension and Communications,” Submitted to the Securities and Exchange Committee by Siegel and Gale, February 15, 2012.
These findings prove ignorance of material facts.
Incontrovertible Imperatives for Zero Risk at the Target Date
1. There is no fiduciary upside to taking risk at the target date. Only downside. The next 2008 will bring class action lawsuits.
2. There is a “risk zone” spanning the 5 years preceding and following retirement during which lifestyles are at stake. Account balances are at their highest and a participant’s ability to work longer &/or save more is limited. You only get to do this once; no do-overs.
3. Most participants withdraw their accounts at the target date, so “target death” (i.e. “Through”) funds are absurd, and built for profit.
4. Save and protect. The best individual course of action is to save enough and avoid capital losses. Employers should educate employees about the importance of saving, and report on saving adequacy.
5. Prior to the Pension Protection Act of 2006, default investments were cash. Has the Act changed the risk appetite of those nearing retirement? Surveys say no.
6. Ignoring the past (especially 2008) and hoping it’s different the next time is not an option, and it’s certainly not an enlightened view of risk management.
7. Surveys of fiduciaries say no risk.
Elmer Rich III
There is gold in them life savings!
“BlackRock, the world’s largest asset manager, is starting 10 indexes that will let investors approaching retirement calculate how much their savings will equal in annual income when they turn 65. The New York-based firm filed with the Securities and Exchange Commission to offer five investment-grade bond mutual funds that will be linked to the indexes, which adjust for variables including interest rates<sup class="footnote"><a href="#fn64a69f7a-60b5-4049-bb0d-d069db5ecaf9" rel="nofollow">2</a></sup>, inflation and assumptions about lifespans.
Led by Chief Executive Officer Laurence D. Fink, BlackRock last year started a five-year branding campaign and reorganized its leadership to help improve fund performance as it seeks to expand its retail business. The firm has less than a 2 percent market share in open-end mutual funds, compared with 11 percent for Boston-based Fidelity Investments<sup class="footnote"><a href="#fnb26f5d48-eeb0-4a8d-a0a0-937c8591af24" rel="nofollow">3</a></sup> and 12 percent for American Funds<sup class="footnote"><a href="#fna5023cb0-0785-4301-9a1a-17c89cb3f2a2" rel="nofollow">4</a></sup>, run by Capital Group Cos. in Los Angeles<sup class="footnote"><a href="#fn992af0e4-1b0a-4469-973e-2258ff1d6726" rel="nofollow">5</a></sup>, according to data from Morningstar Inc. (MORN)<sup class="footnote"><a href="#fn86037663-e5d0-4da3-a669-1d0548c0226d" rel="nofollow">6</a></sup>“
Or market top?
Elmer Rich III
What are fid responsibilities in selecting and making funds available? If there is government data showing TD funds don’t work, yet, as promised – what then?
Elmer Rich III
Is retirement money profitable? Oh yeah!
“Managing money for individuals is a lucrative business. It represented about 11 percent of BlackRock’s $3.86 trillion assets under management as of June 30, while accounting for 33 percent of long-term asset base fees” Wow!
“Our staff has reviewed a sample of target date fund marketing materials and found that the materials often characterized target date funds as offering investors a simple solution for their retirement needs. The materials typically presented a list of funds with different target dates and invited investors to choose the fund that most closely matches their anticipated retirement date. Even though the marketing materials for target date funds often included some information about associated risks, they often accompanied this disclosure with slogan-type messages or other catchphrases encouraging investors to conclude that they can simply choose a fund without any need to consider their individual circumstances or monitor the fund over time.”
Source: SEC, Federal Register / Vol. 75, No. 120 / Wednesday, June 23, 2010 / Proposed Rules, page 35922.
I agree with Jim Lauder’s point in his article, Target-Date Managers Who Ignore Risk Should Be Fired, (May 3, 2013): “In most cases, plan participants would rather protect against downside risk than ramp up risk in pursuit of greater returns.”
That is the objective of Vertical Risk Management, to guard against significant downside loss. It should be expected to produce a lower return than taking unmanaged risk. But avoiding large losses can produce better returns. Taking larger risks does not guarantee higher returns. That is the nature of risk.
Elmer Rich III
OK, so we have some data and government data. That is negative and contrary, in fact to claims of downside protection. Is there evidence countering that?
So what is a fiduciary’s responsibility given this fact base?
If the greater chance of loss (“risk”) does not produce a likelihood of greater returns why would the investment with more likely losses be chosen? Diversification? So the “risk-return” trade off does not apply to TD funds?
“Even many professional pension fund consultants who help select retirement plan fund
options offered through defined contribution plans under-estimate the degree of risk in
many target date funds. For example, one unpublished study5 found that, although target
date funds on average exposed investors nearing retirement to a significantly higher
maximum potential loss than most pension consultants surveyed deemed appropriate for
those nearing retirement, only about 35 percent of those pension consultants viewed
current glide paths as somewhat to highly inappropriate (i.e., too aggressive). In other
words, almost two-thirds of these pension consultants assumed that funds were invested
more conservatively than was in fact the case.”
Source: Recommendation of the Investor Advisory CommitteeTarget Date Mutual Funds
(Adopted April 11, 2013).
This might conceivably be the beginning of a larger war between the two giants, involving not only eBooks, but also music, movies and all the other miscellaneous applications that have come for being associate together with the iPhone and, no question, the iPad.
Have any of you looked at the various glide paths of the various TD series funds.
There are some that are so conservation the plan administrator could be fired!!!!!
I have only been in this business for 5 months and it seems that most anyone could obtain this knowledge in the same time. Lots of advisors are being over paid and they do not have a good handle on TD funds..
No more comments & last post on the forum.
Elmer Rich III
The effectiveness of TD funds is an empirical question – what does the data say? Independent data, of course.
Other wise we’re just swapping opinions and stories.
Mr. Rhodes has supplied a lot of interesting and thoughtful material here and has raised a number of key questions. Being the author of the original article, I would like to make a few points:
1) We should differentiate between whether an employee (investor) chooses a Target Date Fund (TDF), or whether it is a “choice” by default. If the investor selects it, employers can presume a minimal level of review. If it is a default “choice,” employers should presume that the investor has not read the material. In the latter case, I think employers should be much more careful in what risks “default investors” are subjected.
2) Subjecting default investors to unmanaged market risks with potentially large losses, as experienced by the major 2010 TDFs, shown in my article (Exhibit 3), does not seem appropriate to me, if the investment represents a sizable portion of default investors financial assets. The majority of pension consultants surveyed agreed that that was too much risk, and in fact thought the TDFs were more conservatively invested and managed than they were.
3) One logical conclusion is that the consultants did not understand how risky the strategies were. I would go further and say that perhaps many of the TDF managers did not understand either.
4) The collapse of 2008 occurred after a 20-year period of good stock market returns. It came as a surprise to many, as Mr. Rhodes stated.
5) The widely practiced investment strategy of holding and rebalancing equity market positions for the long-term exposes investors to potentially large losses, as I demonstrated in my article (see Exhibit 4). It seems inappropriate to me to give a “default investor” that large a market risk in the last 5 years before retirement, if at all.
6) Managing a default investor’s “longevity risk” by preserving purchasing power seems appropriate. For example, TIPS— Treasury Inflation-Protected Securities – may be purchased as a hedge against inflation. The fees charged to the default investor—the other topic—could also be minimal if this is what they own.
7) When people retire, statistics show that the vast majority of them exit TDFs. This implies that either the risks or the fees, or some combination, of the existing products don’t appeal to them. This implies that many “default investors” would not choose the most popular existing products.
8) There is further evidence of this point provided in the study: Investor Testing of Target Date Retirement Fund (TDF) Comprehension and Communications, Submitted to the Securities and Exchange Committee by Siegel and Gale, February 15, 2012. In the section, “Effect of TDF Document Review on Investor Decision-Making,” statistics show that owners of TDFs said they were less likely to include a TDF in their portfolios after reviewing the documents describing them, and were less likely to believe that they are “safe” investments.
9) I believe that the average person can understand basic information about investments based on points 7 and 8 above. I think that default investors may not spend the time necessary to review documents because they expect fiduciaries to more safely invest their retirement savings.
10) This brings me to risk management and Mr. Rhodes’ statement: “More research and discussion of risk management techniques is proper. More extensive back-testing is required to assess the long-term costs and benefits of such techniques. I would appreciate more articles on the subjects discussed below – i.e., use of options, layer cake approach, etc.” I will have a lot more to say about this later.
11) My first point though is that risk management need not require forecasting macroeconomic events. Vertical Risk Management (VRM) is a method that responds to market forces in a systematic way, with the goal of preventing major losses (drawdowns).
12) Mr. Rhodes stated: “Academic research suggests that, on average, tactical asset allocation strategies do not outperform portfolios managed through strategic asset allocation with a disciplined approach to rebalancing.” The goal of VRM is not to outperform the market in terms of earning a higher return, which is how “outperforming” is usually measured. The goal is to provide greater certainty in an uncertain world.
13) I have assessed the risk preferences of many CEOs/CFOs in the energy industry for over two decades and I can tell you that the vast majority of them will choose to take less market risk when their earnings objectives are met through pro-active risk management (hedging). I think many individual investors would make the same choice to take less risk when their retirement goals are met.
Remember the Alamo (2008). Other than that, I’ll not be jousting with you Elmer.
Good points, but some slaps in the face may be what it takes to get the consulting community to wake up. Class action lawsuits are a real possibility when we see the next 2008.The benefits of target date funds are diversification and risk control (professional management), preferably at a reasonable cost, all of which a participant is unlikely to achieve on his or her own. These benefits could be dramatically improved. The industry is moving at glacial speed toward low cost diversification, but risk controls have not changed in response to 2008 – the vulnerable remain in peril as they approach retirement.
Elmer Rich III
OK, so when advising advisors and investors personal opinions of online commentators are the best basis for a decision?
I COMPLETELY DISAGREE with the RAIBiz article. It is apparent the the articles author is getting their information from sources that not really reliable..
Any knowledgeable author of investment articles would have done the due diligence needed to find Morningstars’ Research Paper on Target-Date Fund Series. Anyone can get this off the internet for free. It is a 53-page report that provides investors, investment advisors and 401(k) advisors more than what they need to know.
This article is a lesson making serious errors to do not doing any meaningful due diligence!!!!!!
I think a fiduciary’s responsibilities are: (1) to help a client assess what level of risk is appropriate for the client, and (2) to understand the risks of a portfolio to ensure it matches the risks appropriate and tolerable for the client.
An investment with a lower expected return may be much more desirable if it has less maximum likely downside loss, especially when recovery periods are unknown, and the money is needed in 5 years or less.
I believe that active risk management is needed to guard against significant downside loss, and that means taking little or no risk during financial crises, when large losses may destroy retirement portfolios.
Elmer Rich III
Wow. Long. Clearly TD funds sell, we assume because of the sales promises. Whether they fulfill those promises is a matter of the data. The research quoted suggest not. No one has provided andy evidence they do. If there were we have to assume those facts would be widely promoted
So we have three questions: – Because a retirement product is demanded and successfully sold – should it be. Madoff was very successful his promises, for which there was growing demand.
- Realistically, how productive will more financial education be? The evidence says likely very little.
- What is the evidence that the loss/“risk” management techniques and theories are any more effective than those for TD funds. Options in retirement plans!? How is raising the chance of loss managing the threats of loss?
Finally, back testing is not evidence – it is just post hoc curve fitting.
I suspect your comments are beyond most investment advisors. Absolutely no way to explain to plan administrators and fiduciaries.
If I was the plan administrator, I would have two TD fund series. Aggressive and conservative glide paths. Then provide education for the participants on these funds. Including executives, most participants have no ideas how to allocate there investments. Using charts it is Very Easy to explain.
Providing seminars to education participants that have little background on investment allocation is Wishful Thinking..
Elmer Rich III
“’The risks were not well understood by fund participants,” Well of course. Should investors use any investment for retirement they don’t clearly understand? What is the fiduciary duty?
Sounds like TDS funds are “not ready for prime time.” Sales claims aside.
I did not state a claim that TDFs are bad, contrary to the line in this article:
“Claiming that target date funds are bad because they are misunderstood by investors is rather ridiculous.”
I agree with the SEC’s conclusion:
“Well-designed target date funds can provide a cost-effective long-term investing solution for the many individual investors who find it difficult to construct and maintain a diversified portfolio with risk levels changing to match their evolving needs.”
Source: SEC Advisory Committee, April 11, 2013.
It’s a question of adjusting risk levels to match the evolving needs of people, and needs can vary a lot among people of the same age bracket.
I concur with the author of the article that TD funds are likely to continue to see growth in the defined contribution workplace. For the vast majority of workers, with little understanding of investments, TD funds as the qualified default appear appropriate. Moreover, plan sponsors possess the ability to fulfill their fiduciary duties by selecting high-quality TD funds.
DISCLOSURES ENHANCED. Certainly disclosures can be enhanced of downside risk. Providing historical (or simulated historical) data, in terms of value of $1,000 growth over time (year-by-year), might work far better than percentage disclosures, since few investors understand that the same percentage decline is more impactful than the same percentage advance. Enhanced disclosures might also include best and worst percentage advantages/declines over 1-month, 3-month, 1-year, 5-year and 10-year periods.
While better disclosures, including the use of charts and graphs, would be helpful, we must accept the fact that “investing” will remain “Greek” to the vast majority of plan participants, even after providing them with educational seminars and good educational materials. TD funds, selected appropriately, can be a cost-effective and paternalistic way for a fiduciary to fill the “understanding investments” void so many plan participants will possess.
WORKING BACKWARD FROM RETIREMENT. One issue, alluded to in the discussion, is what should be the target asset allocation at the point of retirement. With most investors possessing decades in retirement, many advisors recommend asset allocations ranging from 60% equities / 40% fixed income to 40/60.
I don’t accept the proposition that target date funds must possess very low risk (i.e., no possibility of a substantial decline) in the year prior to retirement. Rather, perhaps education should be for plan participants as to the appropriate retirement portfolio, and then work backward from there.
Moreover, target date funds can possess varying levels of risk. Such as “2020 conservative” vs. “2020 balanced” vs. “2020 aggressive.” Of course, a 2020 aggressive fund might be managed similarly to to 2030 conservative fund – or be the same fund, for that matter (albeit with different name).
RISK MANAGEMENT TECHNIQUES. It seems to me that the thrust of the original article was on the lack of implementation of risk management techniques by target date funds, as a means of providing downside protection, especially as one approached retirement. There are many risk management techniques portfolio managers can employ. Here are a few …
RISK MANAGEMENT / LAYER CAKE APPROACH. During retirement a way of providing assurance to an individual client would be the use of the “layer cake” approach, in which a portion of the portfolio is allocated to withdrawals over the next few years, a portion is allocated to mid-term needs, and another portion is allocated to long-term needs. I believe Harold Evensky came up with this methodology, and he has written about it in the past. In essence, during market downturns the “short-term layer” may be drawn down, until asset class valuation levels return to near-normal levels. I see how the layer cake approach can add value, both in terms of enabling the client of an advisor to avoid bailing out of the market during downturns (i.e., “selling low”), and also in terms of providing a different means to undertake portfolio rebalancing. However, I also note the original article author’s proposition that at times market downturns can be prolonged over decades, not just 3-5 years. It may be possible to add value to a client’s portfolio using a layer cake approach, but I do not suggest that it eliminates all risk.
However, whether a layer cake approach can be utilized in a target date fund is another question. A significant amount of hand-holding is likely required to enable an individual investor to understand and adhere to the layer-cake approach. Also, incorporation of personal financial planning (as to when funds are needed, discussing discretionary vs. nondiscretionary expenditures in retirement, etc.) may be a prerequisite to the use of this technique.
Hence, perhaps the question should be asked … should all plan participants be permitted to withdraw (i.e., rollover) assets from qualified retirement plan accounts after a certain age? Should all plan participants be encouraged to consult with individual financial advisors five or more years prior to retirement, and possibly move out of target date funds into a different type of strategy during such time frame?
RISK MANAGEMENT / OPTIONS. The idea of providing downside risk to any investment portfolio, whether it be a TD fund or otherwise, typically involves the use of options. It is difficult to back-test such strategies over long time periods, given the lack of data on option prices going back for decades. An article providing extensive (long time period) back testing, with data shown, would be helpful to aid in this discussion. It seems to me that the use of risk management, through options, is a broader issue affecting not just TD funds, but nearly all investment portfolios.
RISK MANAGEMENT / AVOIDING FINANCIAL CRISIS. Another commentator suggests that TD funds should avoid risky investing during times of financial crises. This presumes that the fund manager can predict when such crises may occur. Certainly there were some managers and advisors who were insightful enough to predict the 2008 financial crisis; yet 90% or more did not. The ability to predict macro-economic events, including financial shocks, in my opinion cannot reliably be done by the vast majority of TD fund managers. I doubt TD fund managers will assume any obligation to avoid financial crisis, when there is a high degree of likelihood that they will be unable to predict such events.
Since the 2008-9 financial crisis I have often pondered how macroeconomic risks (or shocks) can be detected/predicted/ascertained, in advance, by investment advisers. As a student of economics and investing, I have been most interested in this topic. Yet, it seems to me that while there may be some advisors who possess the ability to discern financial crises before they occur, I don’t believe I possess that ability. And I am doubtful that TD fund managers, to any significant degree, also possess that ability.
RISK MANAGEMENT / TACTICAL ASSET ALLOCATION VIA ASSET CLASS VALUATION LEVELS. While the 2008-9 downturn was not triggered by a huge overvaluation in equities (unlike 2000-2002, when growth stocks were hugely overvalued), tactical asset allocation strategies could be considered by TD funds in reaction to asset class valuations relative to perceived (or estimated) historic norms. There are many tactical asset allocation strategies based on estimates of asset class valuations; one cannot conclude that they are all doomed to fail, even though the academic research suggests that, on average, tactical asset allocation strategies do not outperform portfolios managed through strategic asset allocation with a disciplined approach to rebalancing.
RISK MANAGEMENT / ANNUITIZATION. Should annuitization strategies be recommended to plan participants, as they approach retirement? Lots of recent academic research in this area, with varying conclusions.
RISK MANAGEMENT / FEES AND COSTS. Lastly, an issue with TD funds is their fees and costs, relative to other investment options made available within the qualified retirement plan. Some criticism of some TD funds has been based on the fact that some TD funds incorporate, as their components, higher-cost funds, relative to index funds or other funds offered within the plan. This is a risk issue for fiduciary plan sponsors.
Plan sponsors, aided by knowledgeable, objective fiduciary (and truly objective) advisors, should be able to discern the total fees and costs of TD funds, and select for the plan the lower-fee-and-cost TD funds available in the marketplace (taking into account other factors in the selection process), as appropriate. Defined contribution plans can enjoy economies of scale, resulting in very low fee levels for plan participants. Given the substantial academic evidence supporting the strong correlation between higher fees/costs and lower long-term returns of funds, fiduciary advisors can play an important role in discerning and recommending lower-fee-and-cost TD funds to plan sponsors. This, in turn, will likely generate competitive pressures on TD fund sponsors to provide better offerings.
CONCLUSION. This discussion has many threads. I would conclude, as to these questions posed:1) Should TD funds possess better disclosures? Yes, but realizing that even with education and enhanced disclosures most plan participants will possess little real understanding of TD funds, or any type of funds for that manner. 2) Should TD funds be utilized as default investment options for plan participants? Yes. 3) Should TD funds possess very low risk levels (i.e., very low allocations to equities), in the years immediately prior to retirement)? Probably not, given the long-term nature of retirement today and the need to take on certain types of risk in an effort to keep pace with inflation. However, plan sponsors might possess less exposure to potential claims (whether valid or not) if they were to offer TD funds with varying levels of risk exposure, and provide education thereon. 4) Aside from strategic asset allocation and rebalancing within the fund, should TD fund managers incorporate one or more risk management techniques? This remains an open question in my view (and perhaps will always be so).
There are many different risk management strategies designed to avoid or minimize downside risk, or to properly manage the portfolio during a period of substantial declines. More research and discussion of risk management techniques is proper. More extensive back-testing is required to assess the long-term costs and benefits of such techniques. I would appreciate more articles on the subjects discussed below – i.e., use of options, layer cake approach, etc.
Can we eliminate the “retirement crapshoot”? By that, I mean, can financial success in retirement not be dictated by “luck” as to when one retires, as to the subsequent investment returns sequence in the crucial years immediately following retirement? Can risk management techniques be utilized, either alone or in combination, to provide greater certainty in an uncertain world?5) Do fiduciary advisors to plan sponsors and plan participants have a role to play? Yes, in aiding plan sponsors in selecting the very best investment alternatives to include in a qualified retirement plan, and in providing educational materials and other resources to plan participants. And in providing personal financial planning to plan participants, throughout their lifetimes.
“I ask them to think about the person who has been in the call center or on the factory floor for the last 30 years…How much risk should an employer be willing to expose them to in the last 12 months before retirement?”
Then he takes a show of hands, asking if people would be willing to expose them to a 1 percent decline. Lots of hands. Five percent? Many hands fall. “I’ve had maybe one hand still up after a 10 percent loss,” he said.
Source: New York Times, June 15, 2012.
There is something wrong when that’s the view of employers AND target date funds were down as much as 40% in the year before the 2010 target date.
Brilliant Robert !!
This month T Rowe is coming out with a TD series. It is expect to be structured with a glide path with 45% in equities for those between the ages of 60 & 64.
Question for you. Given that there are approximately 62 TD fund series it would seem that the Morningstar benchmarks would not work. The only thing I can think to get a relative good index is to construct one using TD funds that have a similar glide path.
What are your thoughts on this idea.
Ron, I have a question for you that I would like to discuss with you outside the the forum. If you have the time, I would appreciate you emailing me at firstname.lastname@example.org
Elmer Rich III
Back-testing and “risk’ modeling nearly collapsed the world’s economy and strongly contributed to the longest and one of the most severe set of losses and value destruction in history. What’s changed?
Why engage in energetic denial – again? It’s public record.
There is are a vast # of articles on this. Do an internet search using some like ERISA 401(k) plans. You will get a # of links to DOL’s ERISA site. Pay particular attention to these.
The internet is your friend!!
You wouldn’t be alone Paul. That’s exactly what John Hancock did — 2 products, aggressive and safe. If there are lawsuits, as I think there will be, which path exposes Hancock?
On moving into, my spouse requested me who was on the door and that i described that it was an older man asking me if I wanted to get an apple pondering that potentially he is a burglar casing the house to check out if any one is home!