Ralph Segall, chief investment officer at investment management firm Segall Bryant & Hamill, admits target-date funds (TDFs) have been a helpful retirement industry innovation for the average, unengaged retirement saver in a defined contribution plan. However, more affluent investors are not necessarily best served by the prepackaged strategies, he says, which generally assume the individual plans to spend all assets prior to death and must limit risk as much as possible as one surpasses the retirement date.
Segall notes that his firm supports a variety of client types, from institutional retirement plans to wealthy individual investors, giving a cross-channel perspective on investing trends and challenges. In recent years the notion of the portfolio glide path has become increasingly important, he says, but as helpful as it is to give some people a tool to automatically ramp down equity exposures over time, it’s not an appropriate strategy for everyone putting money away for retirement.
“Something that sets us apart, I think, is that we often tell people that it’s really a mistake to follow this type of a glide path,” Segall tells PLANSPONSOR. “Our identity as a long-only equity investment manager has a lot to do with this position.”
Segall explains his firm’s alternative thesis to glide path investing grows from the need to limit volatility in retirement portfolios, given that the retirement date for two early career individuals can vary by years (even decades) and that people tend to make bad investing decisions when markets are suffering. The firm consistently gets requests and questions from client (whether a wealthy individual or a pension fund) seeking “all the return in the world for as little risk as possible.”
“Of course that’s a desirable outcome from the client perspective,” Segall notes, “but as the investment manager, how can we deliver something like that? How can we deliver the significant and reliable income that is needed while preventing the downside catastrophe?”
Segall feels the typical TDF offers nothing like an answer to this question, nor is it designed to. The whole premise of a TDF is to take as much risk as possible during the earlier years of the glide path, he says, with equity exposures dialing back nearer to the retirement date. This thinking is built on the premise that investors won’t mind taking big hits in their accounts, Segall explains, so long as their retirement date remains far off.
In many ways this thinking is not responsive to real-world behaviors, Segall suggests. For example, a bout of significant volatility in the Fall of 2014 caused 401(k) plan participants to get jumpy about their equity holdings, as measured by the Aon Hewitt 401(k) Index. At the time, Rob Austin, director of retirement research at Aon Hewitt, told PLANSPONSOR that up until that point in 2014, the year was shaping up to be “an incredibly light trading year overall.”
Then the first 13 days of October brought five days of moderate or high trading activity. To put that in perspective, from January through September 2014, there had been only 12 total moderate or high trading days among 401(k) plan participants. The highest trading days for 401(k) participants for the year clustered right on and after the days when the S&P 500 lost 1.5% or more.
When individuals were making trades, they tended to move from equities and into fixed income, the Aon Hewitt index shows. “We experienced a few daily declines of around 2% so far in October,” Austin said, “and clustered right around those days we saw a lot of activity—people were clearly saying, ‘Get me out of here, I don’t want to be in this volatile market.’”
For the most part, individuals were selling depressed equity shares (including TDFs) and buying fixed income.
“If you look back to how poorly many TDFs would have performed during the 2000 technology crash and through the 2008 financial crisis, you can see why this type of approach can be hard to stomach for many retirement savers,” Segall says. “Our goal is different. We seek to build a mix of securities that, admittedly, isn’t going to climb 30% in a year like 2013, but it’s also not going to go down 35% in a year like 2008.”
What does the alternative to glide path investing actually look like? Segall describes it as a “total return perspective”—and one that does not seek returns in a front-loaded way.
“What that means is that for portfolio returns, we don’t really care if it’s coming in the form of dividends, interest or appreciation,” Segall explains, “and we seek a much smoother return path over time, to avoid some of the problems we have already talked about with individuals pulling money out of the markets at exactly the wrong time—selling equities when they are down and buying when they’re up.”
Similar to a pension fund, which operates according to a long-term return target, Segall says individual retirement portfolios should operate against a specific annualized return target. He puts this return target at about 5% annual, stressing that this is should be viewed as a “very long-term” average return figure, one which reflects the long-term rate of real global economic growth.
Segall says investing this way is like playing tennis. “I’m not a very good tennis player and I’m not good at hitting the big winning shots,” he says, “but if I can keep that ball going back over the net, I’ll stay in the game. That’s sort of the thinking here. You manage not to lose in the short term, and in the long term, you win.”
Segall says this thinking has one other important result: portfolios built with a more consistent return path that limits volatility can deliver on more than just the goal of making sure one has enough money to pay for retirement expenses. They can be an effective vehicle for growing and passing along wealth to younger generations.
“Another critical question that we ask our individual clients is, what do you want to do with this money you have saved in the retirement plan?” Segall explains. “Will you spend it all before you die? If so, perhaps the risk-mitigation conversation is the right way to go at this point. But we have found many clients don’t want to spend it all—especially as you move to the more affluent portions of the market.”
Some affluent clients have plans to leave money to their children, Segall says, or perhaps to a favorite charity or even their alma matter. When this is the case, the portfolio’s end date “shoots way out again,” he says, again making a glide path inadvisable.
“This is a portfolio that still has a long-term investing horizon, even though it might be held by a 75-year-old right now,” Segall explains. “As a practical matter, the elder person becomes an income beneficiary on this pot of money, and we shouldn’t be managing the money to that persons’ life expectancy. Many affluent retirement portfolios continue to have this long-term horizon.”
Segall concedes that, given industry predictions, TDF investments will likely continue to gain popularity, but he predicts some problems will emerge with the trend.
“Once you start looking at actuarial assumptions about how long people are going to live, this thinking doesn’t even have to apply to passing on the portfolio,” Segall notes. “How unlikely will it be for a healthy 62-year-old retiree today to live to 102? That’s still a 40-year time horizon—about the same that you have on a 2055 target-date fund.”
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