GMO took a look at several variables retirement plan advisers and sponsors can consider when selecting a target-date fund—such as active versus passive, level of risk, dynamic versus predetermined glidepaths and custom versus off-the shelf—and how these factors would have resulted in outcomes for the 40-year period between 1975 and 2015.
Other factors that GMO looked at included: proprietary underlying funds versus open architecture, traditional versus alternative investments, “to retirement” versus “through,” and auto escalation versus not.
In “Target Date Decisions, Decisions … Getting the Biggest Bang for the Buck,” GMO concludes that dynamic allocations paired with higher-than-typical deferral rates can result in significantly better outcomes for participants—and that these are the two most important factors that sponsors and advisers should consider when selecting a TDF and the plan design around it.
GMO also found that passively managed investments should be included in TDFs, noting in its white paper, “It is clear from the scoreboard that active management across this [40-year] time frame did not add value. The takeaway: Plan sponsors should not obsess about open-architecture active frameworks.”
NEXT: What level of risk should a TDF take?
GMO next looked at how TDFs with more conservative glidepaths would have fared compared with those with more aggressive approaches, and found a 6% disparity in performance—conservative TDFs ended up with 2% less assets and aggressive TDFs with 4% more. GMO concluded that whether a TDF has an aggressive or conservative glidepath should not be a driving force for sponsors’ and advisers’ selection of TDFs.
GMO notes that when TDFs first hit the market, they were designed with pre-determined glidepaths, which the firm believes is a faulty approach for an investment that can last 40 years or longer. GMO learned that dynamic glidepaths can increase a participant’s TDF balance by as much as 14%, making this a significant factor when choosing a TDF.
And increasing a person’s deferral rate by even a mere 1%, from 6% to 7%, can boost their balance by 11%, again, a factor that GMO believes is meaningful.
GMO concludes, “Based on our results, the two most promising levers appear to be adding a dynamic component to the glidepath and boosting deferral rates”—and if these two factors are combined, balances could increase by as much as 30%.
GMO’s white paper can be downloaded here.