The Department of Labor’s (DOL’s) 2013 Tips for ERISA Plan Fiduciaries identifies some key variables for fiduciaries to consider that can meaningfully impact the shape and overall design of a TDF’s glide path. Thus far, the DOL’s tips have made a positive impact, highlighting the need for plan fiduciaries to look beyond standard historical performance and risk-based metrics, which many decision makers have come to heavily rely on when evaluating core investment menu options or overall TDF providers’ solutions.
Moving forward, a focus on understanding and implementing best practices in glide path risk management is critical for plan fiduciaries. Common TDF risk management techniques today include a systematic transition to a more conservative allocation over time, and broad diversification among asset classes and securities. While sound financial planning concepts, the value these practices can provide will vary in the context of prevailing market conditions over time.
Most plan sponsors would agree that as participants age, their TDF asset mix should generally become more conservative. However, history has illustrated that there will be market environments when the risk of capital loss warrants adjusting the glide path’s original construction.
Likewise, certain asset classes will inevitably be more attractively valued than others at times. Without an active asset allocation approach, participants may have exposure to certain asset classes when they are priced to fail to achieve participant goals, such as U.S. Treasury bonds today. Furthermore, as evidenced through most of the 2008-2009 environment, diversification among risky assets often disappears when participants need it most. As such, diversification alone is not enough to meet a participant’s long-term goals.
Given the impact that changing market dynamics can have on participant outcomes, the new standard for TDF due diligence should acknowledge that the most appropriate asset mix at any point along the glide path cannot be precisely determined ahead of time, and that it is highly dependent on the prevailing environment. As a result, evaluating the TDF provider’s experience and expertise for making asset allocation decisions should be an important part of the due diligence process.
While the prevailing market environment becomes a key determining factor in the ability to achieve participants’ goals at later life stages—a time when retirement balances are relatively high and the ability to recover from capital losses is more limited—it can impact participants’ saving behavior throughout their working careers. Protecting assets by managing downside risk in difficult markets is important not only from a performance perspective, but equivalently, from a behavioral standpoint—by creating an experience where participants are less likely to make costly decisions at the wrong time (i.e., reactively reducing equity exposure, scaling back or stopping contributions altogether, when the risk of large losses is magnified). Since no single glide path can meet participant needs in all environments, plan fiduciaries would be better-served to use a “glide range,” with flexibility to manage risk along the different points of participants’ lives, as market environments change.
As a target date nears, a “glide range” transitions toward more conservative allocations, but can also make adjustments within a broad asset allocation range, based on prevailing market conditions. Using this approach, plan sponsors can help balance conflicting participant goals—such as capital growth and capital preservation. This is important because participants defaulted into TDFs may be more inclined to place a higher priority on capital preservation and protection during challenging market environments, even though they may inadvertently ignore other risks potentially impacting their portfolios.
Contrasted with the typical glide path, which focuses only on reducing equity exposure mechanically on an annual basis, a glide range is built with the flexibility to also address the prevalent risks in the current market environment that most impact a participant’s portfolio. A “glide range” allows the TDF manager to weigh various indicators such as equity market valuations, interest rates, economic growth, and investor sentiment in the context of the various phases of a participant’s lifetime—early career, mid-career, and near retirement.
Implementing a flexible “glide range” that moves beyond the status quo requires plan fiduciaries to concentrate risk assessment efforts on better understanding what method, if any, their TDF manager uses to manage such risks.
The evaluation of a plan sponsor’s TDF manager and its glide path, in line with the aforementioned due diligence discussion, should also include a thorough review of a manager’s asset allocation process and results throughout a full range of market and economic conditions.
Only after this careful type of review, are plan sponsors better-positioned to help participants achieve their retirement savings goals—as market conditions and risks inevitably change over time.
Jeff Coons, president of Manning & Napier
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author(s) do not necessarily reflect the stance of Asset International or its affiliates.