Careful Considerations

Target-date funds (TDFs) differ significantly from fund to fund, and each target-date fund manager has a different investment philosophy underlying how to invest assets over the fund’s time horizon. One of the lessons people learned from experience in 2008 and 2009 is that there is much to consider when performing due diligence on these funds. To that end, it is crucial that plan fiduciaries understand the investment philosophies behind the target-date funds they either are considering or have selected for their plan. Glenn Dial, managing director and head of retirement distribution for Allianz Global Investors, and Bradford Campbell, counsel at Drinker Biddle & Reath, spoke with PLANADVISER about the fiduciary responsibility that applies when picking such funds and what plan sponsors and their advisers should consider before adding a particular target-date suite to a retirement plan.

PA: What are the fiduciary issues that plan sponsors should consider when selecting a target-date fund suite for their retirement plan? 

Bradford Campbell: Selecting a target-date fund for a plan is a fiduciary decision under the Employee Retirement Income Security Act (ERISA). Plan sponsors, therefore, must consider a variety of factors to evaluate a particular fund suite and then fully understand the fund they’re selecting.

First of all, is it a “to” fund or “through” fund? Funds with the same target date might have quite different investment philosophies, depending on whether they’re “to” or “through.” “To” funds are intended to reach a more conservative allocation at or near the target date, while “through” funds are intended to reach a more conservative allocation well after the target date.

Next, plan sponsors have to examine other relevant factors—the cost of the funds, how the manager notifies sponsors of investment philosophy changes, how the fund and its philosophy fit in with plan demographics, and so forth. Plan sponsors also have to consider the needs of plan participants. Are participants likely to withdraw their funds at the target date or will they stay invested in the plan? That can help determine which fund best fits the needs of a plan and its participants.

A plan sponsor’s fiduciary duty, at its root, is the same when making a decision about a target-date fund as it would be for any other fund. He can’t pick one because it’s the only option. He needs to have an affirmative reason for his selection.

PA: What is Allianz Global Investors doing to help educate retirement plan advisers and plan sponsors about these fund differences and then narrow down this universe of target-date funds? 

Glenn Dial: When we look at an adviser’s entire client base of plan sponsors, we know, based on their behavior patterns and demographics, that some are going to be more suited for a “through” fund and some more suited for a “to” fund.

To help facilitate the selection, Allianz Global Investors has developed a two-part tool to help advisers educate plan sponsors about the differences in target-date funds and then find the best option for a particular retirement plan and participant group.

The Target-Date Tool Set has a qualitative component, which is a questionnaire about participant behavior and the goals and objectives of the plan sponsor. It even digs down into details about the limitations of the plan’s design and any associated distribution fees, which could actually limit the type of fund that can be on that platform. That questionnaire is followed by a quantitative component, comparing multiple fund families that, based on the answers to the questionnaire, may be appropriate for the plan.

PA: When evaluating a fund suite, what components are particularly important for plan sponsors to consider? 

Dial: The first thing to do is narrow the list of funds for comparison; you want to compare “to” funds to other “to” funds and “through” funds to other “through” funds. In our opinion, you would never compare a “to” fund to a “through” fund, because they have completely different objectives. It’s the same reason you’d never compare a large-cap fund to a small-cap fund.

Once the funds are selected for comparison, we look at them side by side and examine the glide paths more closely. We’re looking at how much risk is being taken at or near retirement, the number of asset classes and how much inflation protection is being provided in each vintage. We think the Sharpe Ratio is an important measure and that upside and downside captures for each vintage are critical metrics.

Of course, depending on the vintage, certain metrics are more important than others. For instance, if we’re looking at the 2015 vintage, standard deviation and Sharpe Ratio are extremely important but not as important to the 2050 vintage. On the other hand, return is probably more important when you’re looking at the 2050 vintage and less so when looking at the 2015 vintage.

Part of the appeal of our new Tool Set is that it visually compares all these metrics; it shows the entire series or all the vintages of each fund family beside each other in a visually appealing way. This allows plan sponsors to better see the differences in the funds, because you have to look at the entire series of one manager next to the other.

PA: How does an adviser or plan sponsor use a tool of this kind to help document the fiduciary process? 

Campbell: The fiduciary still has to make his own determination based on the unique circumstances of a particular plan. However, this kind of tool can help pull together the information needed to analyze that decision. It also helps create a documentation of the decision-making process. Obviously, one of the things that the ERISA attorneys say over and over is “process” and “documentation.” A tool kit like this can help plan sponsors both develop a process and then document the work that was done.

Figuring out the right process for gathering that information and consolidating it to help you reach a solid, prudent fiduciary decision can be a challenge. That’s where something like this tool set can help you: gathering the right information and questions that help you arrive at the right conclusion for your plan.