Prudent Investment Review Processes Need Not Change During Volatility

However, serious downturns can reveal risks plan sponsors didn’t know they had.

Investment managers agree that if plan sponsors were already performing adequate due diligence to review the investments in their plans, an uptick in market volatility should not prompt them to change that process.

However, they also agree that market volatility is likely to reveal that not all target-date funds (TDFs) performed on the same scale, and if they have one of the laggards in their plan, they are likely to replace it.

Lorie Latham, senior defined contribution (DC) strategist at T. Rowe Price, says, “The bottom line is, any volatility should not prompt a different due diligence process for plan sponsors. If the plan committee was already doing its due diligence and it was a sound process, nothing should change. To be a good steward to the plan, the last thing you want to do is reverse course from long-term principles.”

Tim Kohn, head of defined contribution services at Dimensional Fund Advisors, agrees. “Prudent selection and monitoring of funds—like ERISA [Employee Retirement Income Security Act] tells us—should be in practice in all time periods,” Kohn says. “I don’t think it should increase during periods of volatility.”

That said, because of the extreme volatility in the first quarter, Willis Towers Watson is telling its plan sponsor clients to check whether the risk profile they chose in their TDF was consistent with its performance in the quarter, says Jason Shapiro, director, investments. They really need to scrutinize the fund’s glide path, he says.

Sponsors also need to figure out whether retiring participants remain in the plan or leave, which will guide their decision on whether to offer a “to retirement” TDF or a “through retirement” TDF, Shapiro adds.

Rick Fulford, head of PIMCO’s defined contribution business, says that because of the 10-year bull run, the equity weighting in many TDFs rose to a level sponsors were unaware of. “In this environment, where we had high returns for such an extended period, TDFs’ concentration in equities undoubtedly rose, and many plan sponsors will discover they didn’t understand the risk they had in their target-date funds, particularly in those near retirement,” Fulford says.

Jake Gilliam, head multi-asset strategist at Charles Schwab, also warns sponsors about risk “When markets turn as they have, it very quickly exposes risks sponsors didn’t know they had. They need to deliver the right amount of risk for the life stage of each investor.”

Mike Swann, client portfolio manager at SEI, says the overweight in equities in TDFs is deliberate. “There has been an arms race among the largest and most popular target-date funds in the past 20 years to compete with each other on performance,” Swann says. “They know that is how plan sponsors and consultants judge these funds, and they have been increasing their equity exposure to gather more assets under management [AUM]. Unfortunately, that fails participants near retirement. Participants may not understand the amount of risk in those funds near or at retirement.”

Fulford says most TDF managers will tout the diversification in their glide paths, but there are nuances to find in that. “I expect plan sponsors will take a much closer look at the risk in their target-date funds. We are also advising clients to ask if the glide path is sufficiently diversified—across asset classes, regions and sectors, and whether there is too much U.S. bias or equity risk. They should also ask their TDF provider if volatility management is a high priority, especially for those near or in retirement.”