From the inaugural issue of 401(k) Specialist magazine: Once they were loathed, now they are loved. Who’s on top with target date funds? Morningstar clues us in on what’s new with the 401(k) staple
Who knew? It was only a few years ago that target date funds were considered a colossal disappointment. Glide paths were off, leading to early-inception underperformance and the dubious honor of ending up on many financial experts’ “products to avoid” lists.
No longer; the 2015 Morningstar Investment Conference was more like a TDF debutante ball; a reintroduction of the product with plaudits from conference presenters and a major reinforcement of why they’re so popular in 401(k)s. High praise was given not only for TDF performance overall, but also for their role in minimizing the more destructive behavior displayed by investors during 2008 and the ensuing recovery.
A research roundtable during the conference’s opening afternoon, moderated by John Rekenthaler, Morningstar’s vice president of new product development, was particularly positive. “We see target date fund investors, in particular, behaving very well,” said Laura Pavlenko Lutton, a director of manager research at Morningstar. “Especially in 2008, they did not panic and reached the rebound of 2009.”
Russel Kinnel of The Fund Spy fame agreed, noting that “TDF investors received far and away the best returns” over the past few years, and credited the funds “boring structure” for the absence of self-sabotaging behavior.
“We heard around 1999 and 2000 how supposedly 401(k)s were deficient and investors wouldn’t be the first to crack, and that the savings vehicle wasn’t structured properly and it wouldn’t hold up,” Rekenthaler added. “But the opposite was actually true. TDFs were strongly positive through 2008 and 401(k) investors stayed put more so that other types of investors. This is something that analysts and researchers are now studying.”
But it wasn’t all wine and roses. In a separate interview, target date fund analyst Jeff Holt took a more measured approach when asked how target date funds are performing overall.
“It depends on the series, and the glide paths within the series,” Holt soberly replied. “It sounds obvious, those with a heavy allocation to asset classes that have done well have performed well as a result, so U.S large-cap for instance,” he explained. “Fund families like J.P.Morgan (which got the 2014 allocator of the year for SmartRetirement series) and American Funds are examples. But those that have a heavy allocation to, say, emerging market stocks haven’t done as well.”
But when asked a follow-up, how investors are doing with target date funds, he agreed with Lutton and Kinnel.
“Investors are using them well. They don’t exhibit the typical behaviors of fear and greed with target date funds, and as a resultstay the course and remain invested longer.”
He noted that the “big three” of Fidelity Investments, Vanguard and T. Rowe Price, still dominate the market, but that dominance has recently waned.
“Target date funds tend to be very sticky, and those three companies account for 70% of the assets in TDFs, but that has come down from 75% and even 80%.”
As for TDF innovation in the near-future, Holt said it will focus heavily on retirement income payout systems, such as incorporating deferred annuity-like solutions into withdrawal systems.
“The focus has been on asset-class diversification on the way up to retirement, but not as much in or through retirement. That will start to change. It might be adding alternative investments, for instance, but that would add cost and complexity, and TDFs are known for their simplicity.”
Hybrid funds, he added, will also become more prevalent, and he specifically mentioned recent releases from PIMCO and The Principal that combine active and passive allocations to their TDFs.
“One interesting thing is that glide paths usually stick to equity and bond allocations, but we decided to peel it back a level further. We looked into exactly what was in the equity and bond allocations. What was the ratio of domestic to international equities, what about corporates versus TIPS, that sort of thing?”
He emphasized that it is incredibly important for plan sponsors and retirement plan advisors to know what the specific allocations consist of.
“You can’t go completely passive in TDFs because managers still have to make active decisions about allocations, regardless,” Holt concluded. “This is especially true now that the DOL has increased scrutiny as they attract more and more assets. It’s more important for plan sponsors and retirement plan advisors to really know what’s in them.”
Here is more information on the innovative products and fund families mentioned.
J.P. MORGAN SMARTRETIREMENT TARGET DATE FUNDS
When asked about how the team constructs its glide paths, J.P. Morgan’s Anne Lester pointed to the aforementioned investor behavior.
“Just as a snapshot of how we think about it, people like winning, and it feels really good when you make money,” Lester told Morningstar’s Leo Acheson in January upon receiving the award. “But, man, do people hate losing. And when you lose money or when you fall short, it actually hurts twice as much as winning makes you feel good. So, that was an integral insight into the way we thought about managing risk.”
The J.P. Morgan SmartRetirement target date suite is managed by a team of just over 100 investment professionals located in London, New York and Hong Kong. It claims access to over 250 investment strategies, as well as proprietary insights into asset allocation, investment selection and risk management.
AMERICAN FUNDS TARGET DATE RETIRE FUNDS
Nothing fancy here, but maybe that’s the point. American Funds notes that the 11 funds in the American Funds Target Date Retirement Series are designed around retirement dates that are spaced five years apart, ranging from 2010 to 2060.
“Each of the target date funds could serve as a single, diversified retirement investment,” according to the company. “Each fund invests in a mix of American Funds—mutual funds managed with a long-term focus based on thorough research and attention to risk.”
Fund portfolios are managed and periodically adjusted over time. The funds have a more growth-oriented strategy when retirement is years away and a more income-oriented focus as the fund gets closer to its target date. The target date is the year in which an investor is assumed to retire and begin taking withdrawals.
After the retirement date is reached, it concludes, each fund will be managed for 30 years to pursue income, capital conservation and some growth.
MANAGED RETIREMENT INCOME PAYOUT FUNDS
Like their TDF older siblings, managed payout funds have experienced some serious tweaks in their relatively short life, but now seem to be doing better.
“Managed payout funds are mutual funds designed to provide a steady stream of retirement income while still allowing retirees access to their money during their lifetime,” noted Diana McCarthy and David Williams of fiduciary powerhouse Drinker Biddle & Reath in 2013. “The launch of these products coincided with the economic downturn, which adversely affected their popularity and growth for a time. As the economy has rallied, however, managed payout funds are gaining more assets.”
They conclude by reinforcing Holt’s point.
“They are probably most useful for investors who have other sources of steady income, whether they be annuities, GMWBs, pensions or other sources.”
PIMCO REALPATH BLEND
It lost Bill Gross, but gained some hybrid target date funds. PIMCO announced in May that it’s expanding its target date fund offerings with RealPath Blend, “which is designed to help investors build wealth while generating enough income to sustain their lifestyles throughout retirement.”
“Underpinning RealPath Blend is the same philosophy we’ve been following since 2008: it’s not just how much you have at retirement, it’s how much you can afford in retirement that really counts,” Rick Fulford, Executive Vice President and Head of U.S. Retirement at PIMCO, said in announcing the funds.
RealPath Blend optimizes (read lowers) cost without compromising value by combining active management for fixed income and passive indexing for equity allocations.
PIMCO’s distinctive glide path includes investments beyond traditional stocks and bonds that can help deliver strong returns in a variety of market scenarios.
In addition, RealPath Blend’s explicit focus on downside risk management should limit potential losses in challenging markets.
“RealPath Blend seeks to give savers the confidence and certainty they deserve when planning for retirement by smoothing the experience and helping them stay invested throughout market cycles,” Fulford concluded.
PRINCIPAL LIFETIME HYBRID FUNDS
The management team of Jeff Tyler, Randy Welch and James Fennessey have a combined 76 years of portfolio management experience. According to the company, the Principal Lifetime Hybrid Series, introduced in 2014, offers:
Potential for growth while managing cost — “Savvy investors seek excess returns but keep a close eye on expenses. The Principal LifeTime Hybrid Series is designed for both objectives. The series offers: Active, specialist managers in asset classes where we believe greater opportunity exists to add potential for excess performance; Passive management in historically more efficient asset classes to take advantage of lower costs.”
A glide path carefully designed to address key investor risks — “Target date series are designed to evolve as investors’ risk profiles change over time. The way a glide path is designed can help manage specific investor risks such as: Savings shortfall; longevity; capital; inflation. The series glide path seeks to manage all of these risks in an effort to help investors achieve a successful retirement.”
The expertise of an industry leader — “Principal Funds is the largest mutual fund provider of active multi-managed target date choices. The Principal LifeTime Hybrid Series is managed by a team with a long-term track record of target date investing over a variety of market environments to help deliver solid returns as investors prepare for retirement.”
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
