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Target date fund offerings and the underlying asset allocation methodology is being changed by a number of large investment managers and financial asset managers.

Background:

A recent article describing some target date fund changes was recently published on Investment News.com: Lock ‘n’ load: Taking target funds tactical. The general principal of the article is that a number of investment managers have modified or plan to modify their target date fund offerings to reduce volatility and equity exposure in a portfolio during times of market dislocation.

Reaction:

In theory, this is a normal and well-thought out response to Congress and investors’ concerns. Many investors’ concerns center around a lack of understanding the glide path as a target date fund neared its “maturity date”. As a result, investors suffered large negative returns during 2008 in their Defined Contribution target date retirement savings when they expected the investment manager to have already positioned the target date with a reduced concentration on equities.

However, like many other things, there are always unintended consequences and I believe these changes to target date funds to reduce volatility and equity exposure fall into that camp. There are two specific consequences that come to mind:

1. Comparison of investment manager and target date performance could be hindered.
2. Participants more likely to experience retirement savings shortfall as a target date takes less equity risk and relies on the investment manager to “time the market”.

Alternative Approaches to Target Date Changes:

Rather than modify existing target date fund offerings, investment managers could also take a number of alternate approaches.

• In the first alternative, investments managers and asset managers would establish 2 different breeds of target date funds:
  • The first and existing target date offering would manage the portfolio as saving UNTIL retirement.
  • The second and newly created offering would manage the portfolio as saving THROUGH retirement.
  • By creating such a distinction between the 2 breeds of target date funds, fund managers could appropriately position the glide path.  Since most plan participants in existing Defined Contribution target date funds already thought they were in a fund that saved UNTIL retirement, a plan sponsor could undertake a communication and education campaign to notify staff of the differences in the target date offerings.

• In the second alternative, one which is already active by a number of investment managers, managers would offer guaranteed or managed payout income funds along with a target date glide path. In fact, Vanguard, Fidelity and DWS Investments already have such offerings and AB announced their intention to create a multi-insurer guaranteed target date offering.

Overall, these changes to target date funds to reduce volatility and equity exposure during times of market dislocation are not likely to be a net positive for most plan participants.
What plan participants need is greater transparency into how their target date savings are being invested, paired with a continued emphasis on participant communications.

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