How quickly we forget. Almost 60 percent of 401(k) plan sponsors surveyed say they consider a track record of three years or less when selecting managers. Additionally, three-quarters say they will put an investment manager under review based on underperformance over either one or three years.
This short-term focus is damaging to plan performance, according to MFS Investments, which notes in a new report that it’s “clear that the lessons of the last market downturn seem to have faded from the collective consciousness of many plan sponsors.”
“Many sponsors have succumbed to short-term pressures—and these are often misaligned with the long time horizons of plan participants,” Ryan Mullen, senior managing director and head of MFS’ Defined Contribution Investments practice, said in a statement. “The effectiveness and skill of an investment manager can only truly be judged over a full market cycle, which is longer than three years.”
According to the survey, titled “MFS Defined Contribution Investment Trends,” performance and fees are two of the most important factors that plan sponsors and plan advisors look at when selecting target date funds. About two-thirds of those surveyed say investment performance is one of the most important things they look at when selecting target date funds, while 46 percent say fees are one of the most important factors.
“Plan sponsors tend to focus on performance as a key indicator of successful retirement outcomes,” added Ravi Venkataraman, global head of Consultant Relations and Defined Contribution at MFS. “But the importance of asset allocation and risk management in driving performance is often overlooked. And as we saw during the global financial crisis, these factors can have an outsized impact on the performance of a target date portfolio.”
Portfolio construction matters
Just 40 percent of sponsors surveyed say the asset allocation process is one of the most important factors, and only one-third say they look at risk management when selecting a target date fund. Among plan advisors, just over half say the asset allocation process is one of the most important criteria when selecting target date portfolios, while 35 percent say an embedded risk management process is a key area of focus.
“In recent years, fees have had an overarching influence on the selection of retirement plan menu options,” Mullen said. “What’s interesting is that two-thirds of the advisors we surveyed say they view themselves as fiduciaries for the plans they advise. As such, we’ll likely see more focus on portfolio construction considerations in the years ahead.”
Risk management in TDFs is much more complex than ‘to’ versus ‘through’
While much of the industry remains focused on the “to” versus “through” and “active” versus “passive” debates, Venkataraman said advisors and sponsors should recognize that there is no such thing as a passive TDF. Investment results are driven by active decisions related to asset allocation, glide path design and risk management.
“Recent market volatility is a good reminder of the importance of proper asset allocation and strong risk management,” Venkataraman explained. “The careful implementation of these principles could help mitigate the potential cost of surprises that can derail investor portfolios, especially for those nearing retirement or those just beginning withdrawals.”
During the last significant market downturn, TDFs designed to take an investor to retirement (the target date) significantly outperformed those designed to take an investor through retirement. Looking at the performance of 2010 target date portfolios from the 20 largest TDF providers during the last downturn, those funds that employed a more conservative “to retirement” allocation suffered average losses of 19.76 percent while those that employed a more aggressive “through retirement” allocation had an average loss of 27.16 percent.
Shifting TDF landscape
Today, the bulk of target date assets are in proprietary funds managed by just a handful of large plan providers. However, nonproprietary TDFs have made headway in recent years. Fifty percent of sponsors surveyed offer target date portfolios managed by someone other than their plan provider. And plan advisors are increasingly steering sponsors to these funds, with 85% saying they always or sometimes recommend an actively managed nonproprietary TDF to their clients.
“Plan advisors are clearly looking at a wider range of target date solutions on behalf of their clients,” Mullen concluded. “Many nonproprietary funds provide access to top-notch investment managers and competitive fee structures.”