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Not so long ago, plan sponsors embraced target-date funds with an enthusiasm bordering on mania. Even today, with the damage of the 2008 market tumult still fresh in their minds, plan sponsors still value the promise of these offerings, newly burnished with guidance from key regulatory bodies. It is a different world, nonetheless, one in which plan sponsors have more options and surely will be held even more accountable for the choices they make.
PLANSPONSOR recently met with two target-date design veterans from Allianz Global Investors: Glenn Dial, Head of Retirement Product Business Development (top right), and Stephen Sexauer, Chief Investment Officer, Alliance Global Investors Solutions (top left), to better understand the latest developments.
PS: What have we learned about target-date fund designs as an industry? Dial: When you look at the target-date funds that have the market share, most of them are what we call managing “through” the projected retirement date, which means they were built with the assumption that participants were going to stay invested in those funds after retirement, withdrawing income from those funds from retirement age through death. However, when you look at what participants actually do in a 401(k) plan, anywhere from 75% to 84% take all their money out shortly after retiring. The inherent flaw in the Generation 1.0 target-day funds is that they assume that the money stays in the plan. I think the Generation 2.0 funds are going to be based more on behavioral finance, aligned to actual participant behavior. PS: How will this kind of thinking affect plan sponsor decisions? Dial: We are all going to be held to the prevailing circumstances at the time that we make decisions. Three years ago, only a handful of target-date funds had a three-year track record, we had not dealt with the 2008 markets, we did not really know the impact of market sequencing risk—the returns you get near retirement, when fund balances are large—back in 2007, and we didn’t understand fully the final regulations on qualified default investment alternatives (QDIAs). Today’s prevailing circumstances are very different. PS: In what ways? Dial: In two ways: First, we now understand what “market sequencing risk” is and why the Department of Labor stated in the final Qualified Default Investment Alternative (QDIA) regulations in 2007 that “a QDIA must be diversified as to minimize the risk of large losses.” Second, consider what Mary Shapiro, the Chairman of the Securities and Exchange Commission (SEC), said in 2009: “Many target-date funds underlying retirement plans actually establish their glide path based on the assumption that investors will continue to maintain their investments and partially live off their proceeds. If that’s the case, it must be disclosed plainly to investors.” The SEC essentially has said that if you’re not managing “to” retirement that needs to be disclosed.
PS: What have we learned about target-date fund designs as an industry?
Dial: When you look at the target-date funds that have the market share, most of them are what we call managing “through” the projected retirement date, which means they were built with the assumption that participants were going to stay invested in those funds after retirement, withdrawing income from those funds from retirement age through death. However, when you look at what participants actually do in a 401(k) plan, anywhere from 75% to 84% take all their money out shortly after retiring. The inherent flaw in the Generation 1.0 target-day funds is that they assume that the money stays in the plan. I think the Generation 2.0 funds are going to be based more on behavioral finance, aligned to actual participant behavior.
PS: How will this kind of thinking affect plan sponsor decisions?
Dial: We are all going to be held to the prevailing circumstances at the time that we make decisions. Three years ago, only a handful of target-date funds had a three-year track record, we had not dealt with the 2008 markets, we did not really know the impact of market sequencing risk—the returns you get near retirement, when fund balances are large—back in 2007, and we didn’t understand fully the final regulations on qualified default investment alternatives (QDIAs). Today’s prevailing circumstances are very different.
PS: In what ways?
Dial: In two ways: First, we now understand what “market sequencing risk” is and why the Department of Labor stated in the final Qualified Default Investment Alternative (QDIA) regulations in 2007 that “a QDIA must be diversified as to minimize the risk of large losses.” Second, consider what Mary Shapiro, the Chairman of the Securities and Exchange Commission (SEC), said in 2009: “Many target-date funds underlying retirement plans actually establish their glide path based on the assumption that investors will continue to maintain their investments and partially live off their proceeds. If that’s the case, it must be disclosed plainly to investors.” The SEC essentially has said that if you’re not managing “to” retirement that needs to be disclosed.
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