PANC 2020: Is It Time to Re-evaluate TDFs?

Since passage of the Pension Protection Act (PPA) in 2006, target-date funds (TDFs) have become the most popular investment option in defined contribution (DC) retirement plans.

“Last I checked—and the numbers are fluid—there’s about $2 trillion from the DC industry is invested in TDFs, and this is mainly because so many plans are defaulting so many people into them,” Daniel Oldroyd, portfolio manager and head of target-date strategies, J.P. Morgan Asset Management, told attendees of the 2020 PLANADVISER National Conference during a virtual session.

Brian Hanna, a partner at Everhart Advisors, said his firm offers comprehensive services, but in the investment monitoring space, monitoring TDFs is 80% to 90% of his focus since that’s where so many assets are. “I spend time educating plan sponsors about the power of re-enrollment and using TDFs as the plan’s QDIA [qualified default investment alternative],” he said. “I focus on helping sponsors have a prudent process for evaluating TDFs. We talk about fit with plan demographics and plan goals.”

Hanna said the bulk of conversations with committees now is about the use of TDFs by participants and the use of whatever do-it-for-me strategies the plan offers. He said conversations used to be about glide paths and risk, but once the Department of Labor (DOL) published its tips for evaluating TDFs, he tells committees that best practice is to focus on those items and document the process.

“The PPA [Pension Protection Act] was as good as it gets as far as retirement plan legislation,” said Nate Palmer, managing director, Portfolio Management Group, Wilshire Funds Management. “It addressed participant inertia and investment diversification. Since then, we’ve had an incredible improvement in retirement outcomes.”

Palmer said that back in 2004, his firm decided to go with custom TDFs for its plan. “There weren’t CIT [collective investment trust] TDFs back then, so we were able to provide a custom solution at a lower cost,” he explained. “We also could offer a variety of active and passive investments—back then TDFs were either/or—and we also wanted to offer more diverse asset classes.”

However, Palmer noted that with today’s new products, there are active/passive blended solutions, CIT solutions, and more asset class diversification, and he said he expects more to come. “There are so many good choices to consider, but if a plan’s participant population is different than average, advisers maybe still should consider custom TDFs,” Palmer said.

The Effects of COVID-19 on TDFs

Oldroyd pointed out that investors essentially went through an entire market cycle within less than a month this year. “In the course of three weeks, the markets dropped approximately 30%, then assets rallied,” Oldroyd said. “Now, we are conditioned that a 1% move in a day is tiny because of the sheer amount of uncertainty.” He noted that year-to-date, the S&P 500 is up 6.25%, and the average TDF at the end of a person’s glide path is up 2% to 4%.

He compared it to the Great Recession, when warning bells went off in 2007, the markets went through a “slow motion train wreck in 2008,” and markets started to rally around March 2009.

That stretched over three years, so plan sponsors may be wondering how to judge their plans’ investment performance this year. “I don’t know if two weeks in March and three weeks in April will merit the same impact as discussions during the 2008/09 crisis,” Oldroyd said. “TDFs are made to continue investing. Those who stuck with it have done pretty well.”

However, he said fixed income will probably be a topic for committee discussion for the next 18 months because the Federal Reserve said short-term rates are not going up any time soon. “The best that happens now is fixed income doesn’t move around much in response to equities versus the usual inverted correlation,” Oldroyd said. “You can determine whether you were too heavily in credit and securitized debt.” He explained that during the COVID-19 pandemic, investors wonder how people are going to pay their car payments, mortgages and credit card debt.

“If something is broken, sell, but if nothing is wrong with the system, think about the long-term and stay put,” Oldroyd said. “I think discussions should be about how to adjust for a brand new market cycle that, I think, is starting now.”

Dislocations in the market, such as what happened this year because of the COVID-19 pandemic, can expose weaknesses in TDFs, Palmer said. There may be tilts and biases within them. For example, he said growth has outperformed value by more than 30%. “The pandemic has identified clear winners and losers, so plan sponsors and advisers might see overweights and deficits in TDFs,” Palmer said. “Never let a good crisis pass us by to help us make things better.”

He said advisers should make sure TDFs are as diversified as they should be in style, and the same thing is true for fixed income allocations in the funds. “This year has taught us to make sure some of the fixed income exposure is in defensive, high-quality, intermediate- to long-duration vehicles or more diversified, all-weather multi-asset solutions,” Palmer said.

As an adviser who speaks to plan sponsors and their investment committees, Hanna said six months is nothing when they consider the long term. “Most of us were not concerned at the plan level or TDF level. It had very little impact. Again, we looked at fit,” he said. He added that he didn’t get a lot of questions from plan sponsors about their TDFs because they were so focused on other impacts to their businesses.

However, Hanna said he did find that he had plan sponsors’ attention about TDFs, and investments in general, for the first time in a long time because there was so much volatility in the markets. He used the opportunity to reiterate to them the importance of making sure glidepaths were appropriate for participants and whether there was sufficient downside protection for those close to end of their glidepath. “They didn’t make a lot of changes, but they listened more,” Hanna said.

The Future for TDFs

Oldroyd said it will take time, but the Setting Every Community Up for Retirement Enhancement (SECURE) Act will have some impact on TDFs, as plan sponsors start to think about in-plan lifetime income. “We are pivoting to what to do with savings once a person gets to retirement,” he said. “There’s been managed payout funds, general income funds, multi-asset income funds, a general concept of options. Guarantees, I think, would be very valuable.”

Oldroyd added that J.P. Morgan Asset Management is exploring combining TDFs with annuities. “We’re looking at how spending needs are going to be variable, using real data about spending in retirement,” he said. “Spending is dynamic so withdrawal rates should be dynamic. We will see more in this space, whether in or next to TDFs.”

Wilshire Funds Management has recently partnered with BNY Mellon for an adviser-facing solution to bring custom TDFs to small- to mid-market retirement plans, Palmer said. “I think it’s going to provide more choice for advisers to create more specialized solutions, and it will better facilitate the inclusion of lifetime income options, which may be coming,” he said.

“We watch, learn and evaluate,” Hanna said. “Sometimes issues that don’t exist are created so solutions built can be marketed, but trusted names will address issues that are there and the industry will embrace them and they will become best practice. I’m excited to watch where it goes.”