Deconstructing Target Retirement Date Funds Western Pension & - - PowerPoint PPT Presentation

Deconstructing Target Retirement Date Funds

November 13, 2013 Western Pension & Benefits Conference Fall Seminar

Outline

• Why Target Retirement Date (TRD) Funds Matter
• Historical Perspective
• What are Target Retirement Date Funds?
• Overview of TRD Funds in the Marketplace
• Characteristics of TRD Funds
• Composition of TRD Funds
• Current Trends
• Best Practices & Conclusions

1

Why TRD Funds Matter

• TRD funds are relatively new but already dominant.
• 65% of plans across the country offer TRD funds.
• On one large recordkeeping platform:
• Of plans that offer a default option, 90% use a TRD suite as the default.
• There is a wide disparity of quality and cost among TRD funds.

Source: PSCA, Vanguard, Janus.

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 2004 2005 2006 2007 2008 2009 2010 2011 2012 % of Plans Offering TRD % of Participants Using TRD

2

Historical Perspective

• Evolution of diversified, multi‐asset portfolios parallels the evolution of

defined benefit to defined contribution plans.

• Default investment popularity has shifted from investment options

appropriate for groups of participants to those for individual participants.

Defined Benefit  Defined Contribution Aggregated Participant  Individualized Participant Characteristics Characteristics Single Allocation  Changing Allocations Plan Sponsor Liability  Participant Responsibility Balanced Products  Target Date Products

3

What are Target Retirement Date Funds?

• Diversified investment portfolios whose allocation between funds and

asset classes automatically becomes more conservative over time.

0% 20% 40% 60% 80% 100% 2060 2055 2050 2045 2040 2035 2030 2025 2020 2015 2010 Income

Target Retirement Date Funds: Sample Glide Path

US Equities Non US Equities Fixed Income Inflation‐Related Cash

4

Characteristics of Pre‐Packaged TRD Funds

Advantages

• Participants can “set it and forget it”
• Professional allocation management
• Asset class diversification
• Automatic rebalancing
• Allocation varies based on age,

becomes increasingly conservative as retirement approaches

• Potentially better returns

Disadvantages

• Glide path is based on “average”

participant so may not satisfy the investment needs of all participants

• No ability to change poor underlying

funds

• Additional education may be needed

5

TRD Funds Offer a Potential Return Advantage

Source: JP Morgan.

• Three‐year return experience of participants on one national

recordkeeping platform (2010‐2012):

6

Overview of TRD Funds in the Marketplace

• The Pension Protection Act of 2006 (“PPA”) designated four types of

investments as QDIAs that give the plan sponsor special fiduciary protection.

– Target Retirement Date funds fall into this category

• Approximately $500 billion is invested in TRD Funds (as of 2012).
• Majority of inflows going to indexed products.

Source: Morningstar.

7

Largest Target Retirement Date Fund Suites

As of December 31, 2012: Fund Family Share of TRD Mutual Fund Market

Source: Morningstar.

32% 26% 17% 4% 3% 3% 3% 2% 2% 1% 7% Fidelity Vanguard

• T. Rowe Price

Principal Wells Fargo American Funds TIAA‐CREF John Hancock J.P. Morgan American Century (Remainder) 76% of market with top three providers

8

Composition of TRD Funds

• Industry Average Target‐Date Glide Path: Equity Allocation

Source: Morningstar.

9

Asset Allocation of TRD Funds

Current Allocation of Top Ten Providers’ 2030 Funds

Source: Morningstar.

Cash US Stock Non‐US Stock Bond Other

Fidelity Vanguard

• T. Rowe Price

Principal Wells Fargo American Funds TIAA‐CREF John Hancock J.P. Morgan American Century

2% ‐ 11% 42% ‐ 54% 13% ‐ 28% 9% ‐ 29% 1% ‐ 5%

10

Asset Allocation of TRD Funds

Return & Risk of Top Ten 2030 Funds’ Current Allocation, Based on History (30 Years):

Source: Morningstar.

Fidelity Vanguard

• T. Rowe Price

Principal American Funds TIAA-CREF John Hancock JP Morgan American Century S&P Target Date 2030 Index Wells Fargo 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0 10 11 12 13 14 15 16 17 18 30-Year Arithmetic Return (%) 30-Year Risk (Std. Deviation) (%)

11

Asset Allocation of TRD Funds

Source: Morningstar, Sellwood Consulting.

Expected Return & Risk of Top Ten 2030 Funds’ Current Allocation, based on Sellwood Consulting Forward‐Looking 10‐Year Capital Market Assumptions:

Fidelity Vanguard

• T. Rowe Price

Principal American Funds TIAA-CREF John Hancock JP Morgan American Century S&P Target Date 2030 Index Wells Fargo 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0 10 11 12 13 14 15 16 17 18 Expected Arithmetic Return (%) Expected Risk (Std. Deviation) (%)

12

Asset Allocation Doesn’t Tell the Whole Story

Three‐Year Rolling Equity Beta of Ten Largest 2030 Funds

Equity beta measured vs. the Russell 3000 Index. Performance history for T. Rowe Price Target Retire 2030 is not available. 13

Glidepath Instability

Source: Morningstar.

14

Glidepath Instability

Source: Morningstar.

15

Composition of TRD Funds: Fees

• Average Expense Ratios for TRD Funds, 2008‐2012:

Source: Morningstar. Average expense ratio is asset‐weighted.

1.04% 1.03% 1.02% 0.99% 0.91%

0% 10% 20% 30% 40% 50% 0.00% 0.20% 0.40% 0.60% 0.80% 1.00% 1.20%

2007 2008 2009 2010 2011 2012 2013

% of Industry Indexed (right scale)

16

Current Trends

• Indexing

– For the first time in 2012, inflows to indexed target‐date funds exceeded those to actively managed target‐date funds – Some actively managed target‐date funds adopting indexed strategies within their funds

• Global Allocations

– Average equity allocation to non‐US stocks has risen from 24% in 2005 to 36% today. – Number of TRD funds investing in non‐US bonds has increased by 33% since 2008.

• Number of TRD funds investing in emerging markets bonds has increased by 50% since

2008.

• Unbundling the TRD Suite from the Recordkeeper
• Custom TRD funds

Source: Morningstar.

17

Best Practices & Conclusions

• Keep in mind who these products are designed for: participants without the

expertise or interest in designing their own retirement portfolios.

– Places burden of monitoring the funds on the plan sponsor.

• Monitoring is essential, especially of active TRD suites.

– Allocations can change – Portfolio managers can leave – Limited ability to make changes to components of TRD funds

• (Good) TRD funds offer ideal default options.
• Choose a provider whose glide path allocation makes sense based on forward‐

looking expectations, not on history.

• Negotiate with your recordkeeper (59% of plans using a TRD suite use the

proprietary suite of their recordkeepers).

• Educate participants about TRD funds.

18

Further Reading & Sources Cited

• Sellwood Consulting:

– Five Common Mistakes 401(k) Plan Sponsors Make

(at sellwoodconsulting.com)

• Profit Sharing Council of America (PSCA):

– 56th Annual Survey of Profit Sharing and 401(k) Plans

(available for purchase at www.psca.org)

• Morningstar:

– Target‐Date Series Research Paper 2013 Survey

(at http://corporate.morningstar.com/us/documents/ResearchPapers/2013TargetDate.pdf)

– Bait and Switch: Glide Path Instability

(at http://corporate.morningstar.com/ib/documents/MethodologyDocuments /IBBAssociates/Bait_and_Switch_Glide_Path_Stability_Final_091211.pdf)

• Vanguard:

– How America Saves 2013

(at https://pressroom.vanguard.com/nonindexed/2013.06.03_How_America_Saves_2013.pdf)

• J.P. Morgan:

– 2013 Defined Contribution Plan Sponsor Survey Findings

(at https://www.jpmorganfunds.com/cm/Satellite?pagename=jpmfVanityWrapper &UserFriendlyURL=contentdet_module&smID=1323364619060)

• Janus:

– Trends in Target‐Date Funds

(at http://bit.ly/1cGwt7w)

19