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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
July 31, 2013 — 5:48 AM UTC by Guest Columnist Jim Lauder
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).
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