MASTERCLASS: Target Date Funds - April 2017

As assets allocated to target date funds grow, the structure continues to be impacted by macroeconomic and demographic trends. A panel of three target date fund industry professionals joins Asset TV for a discussion on the structure of target date funds, how they’re used in retirement planning, and the broader macro conditions they’re considering.

  • Jody Jonsson - Portfolio Manager at American Funds

  • Michael Bapis - Partner & Managing Director at The Bapis Group at HighTower Advisors

  • Robert M. Boyda - Co-Head of Global Asset Allocation at John Hancock Asset Management

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  • 54 mins 56 secs

Gillian: Welcome to Asset TV, I’m Gillian Kemmerer. Assets allocated to Target Date Funds have grown consistently over the past decade and the use of this retirement tool continues to be driven by a number of macroeconomic and demographic factors. We have assembled a panel of experts today to discuss the architecture of Target Date Funds, approaches to using them in retirement planning and the broader global conditions they’re taking into account. Welcome to the Target Date Fund Masterclass. Thank you all so much for joining us here today. You made it through the snow. Michael Bapis: Thank you. Yeah, we did, barely. Gillian: So, I want to start our discussion with just giving some broad strokes views on where we are in the global economy. And we’ll start with the US, Bob, Janet Yellen raised rates approximately 10 minutes ago, I believe it’s the third time in a decade. Broad strokes, what are you seeing for the capital markets in the US? Robert Boyda: So, we have a fairly benign outlook, the fact that rates went up is a positive in our view, because it speaks to a better economic environment, relatively tame inflation. And that’s our view going out three or five years. The good news is you’re growing; the bad news is you don’t like the numbers. They’re still slow, punkish, in fact you look at the broad secular view, productivity’s down, employment growth, while it’s up we’re not producing a lot of new employees. So we don’t have those huge secular tailwinds and that’s going to be mean muted recoveries, what we call half return world. So one to twos on the bond market, four to fives on equity, and if you reach out the risk spectrum and you get into emerging markets, you might see curlier numbers like sixes and sevens. But those numbers are not good by historical standards. And you’re going to pay a relatively big price in terms of diversification, is the only game in town that’s going to help you out. So you’re going to have higher volatility expected and the tamer is going to be diversification. And that’s where of course the architecture of Target Date, Target Risk Funds is spectacular, because it’s a one decision ticket into a fully diversified portfolio. Gillian: So a lot of volatility on the market but perhaps not being rewarded for it? Robert Boyda: Correct. Gillian: Okay. Jody, I know you’re equities focused, but just quickly broad strokes, we’ll drill down on that in a second, what is your outlook for US capital markets inflation interest rates? Jody Jonsson: Well, I would say we probably have a fairly similar view to Bob’s. We still have a debt overhang from the previous financial crisis. We still have demographics that are pointing to an aging population in all of the developed markets of the world. So that tends to mean more muted returns going forward, and probably means that interest rates can’t rise too terribly high, because we still have a lot of debt to service in all of the developed economies. We do think that the US is sort of generously valued relative to its own history, most measures of the market multiple, whether it’s P/E or price to sales or EV to EBITDA would say that the US is on the high side of history, whereas there are a number of markets outside the US that are more attractively valued, clearly there’s political risk there as well. But we look for where value is. We don’t necessarily have a big call on the US versus the rest of the world. But there are many markets abroad where we think there’s a lot of opportunity. And to the environment that Bob described, a key part of our target date funds is the ability to change the type of equity that we hold through time. And so a huge focus of our glide path is equities that are more defensive, that are more income-producing and that have lower volatility. And we think for the type of demographic world we’re going into, that’s a very appropriate investment stance. Gillian: Perfect, thank you. And, Michael, broad strokes what do you see coming down the line let’s say later this year, or maybe even early next? Michael Bapis: Yeah. We’re a little bit more optimistic than Bob and Jody, with caution. We feel that earnings are starting to get much stronger. You have a pro growth administration. It does remain to be seen what will be put into effect, what parameters won’t be able to get done. But we’re more optimistic long term, especially 12-18 months out. We think the debt overhang will be relieved through stimulation of the economy and stimulation of growth and jobs. Gillian: And, Jody, you began our discussion on equities. How are you starting to think about the opportunities internationally? You mentioned valuation comparison, what are you looking for there? Jody Jonsson: Well, the US has outperformed the non-US markets for approximately 87 consecutive months. It’s one of the longest periods of the US beating the rest of the world. And valuations on the US are several percentage points … several multiple points higher than the rest of the world. So we just start looking at the tilt in terms of higher valuations and a larger share of the global market cap for the US. And we just start to try to lead away from that to some extent. I mean we still have a lot of great investments in the US, but on the margin we’re just starting to ask ourselves whether maybe some of the risks abroad are more than adequately reflected in lower valuations. Gillian: Okay. And, Bob, I started with you on fixed income, give us your outlook for equities in the US? Robert Boyda: So we agree that US is relatively steeply priced. And that means in those sorts of markets you are looking at very specific, very actively managed opportunities because it’s rifle shot and very singular names in areas of the market, not the sort of broad, I can just go into US equity and just be there and live wonderfully. And as you go abroad you have to be a little less discriminating because there are sectors of the market that people have been avoiding. I’ll put European financials out there as an example, the growth trajectory looks good, earnings trajectory looks good. You do face some political risk and you do have some transparency risks. But you have very good franchises. And if you look at the US as an example where we were three years ago, no one wanted to touch our financials then and look at how well they’ve done. And so we see those things replaying in the global markets. So yes, I think abroad you have more opportunities at a macro level. And if you’re going to participate in the US, it’s really company and sector specific. Jody Jonsson: And particularly after a long period of outperformance by the US, it makes the case even more strongly for active management, in my opinion, because the stocks that are the largest representation in the index just get bigger and bigger and larger in market cap. So we feel like that just gives more opportunity. And then particularly for outside the US, where research and active management add more value and there’s less competition, we feel like that’s a real opportunity for firms like ours. Gillian: I’ve heard many people in this room say to me whenever I ask, “What’s your outlook international, are there any markets you like?” They always say, “It’s not the markets, it’s the companies in the markets.” So obviously research is very important and active management there would be key. Let’s talk a little bit about the distribution between your equity and fixed income allocations. And, Michael, I’ll start with you, generally speaking how have you shifted your portfolio, whether it’s since the administration or even earlier than that? Michael Bapis: Look, a lot of it depends on the risk tolerance of our clients. The more aggressive portfolios are much more weighted towards equities, the less aggressive portfolios are weighted towards fixed income. We do believe that there’s somewhat of a fixed income bubble, especially going out a bit further on the yield curve. I mean you saw the 10 year go from 1.60 to 2.60, call it roughly rough numbers in seven months, that’s an unheard of move. And it probably won’t go up much higher. But there is a chance that in the future you will definitely see it higher than it is right now. So we’re probably weighted more towards equities and alternatives than we are towards fixed income, but it is a necessary piece of the portfolio, especially as the demographic like we mentioned before, gets older and people are closer to retirement. Gillian: We’re coming back to that in one moment. Bob, how have you looked at this shift between fixed income and equities in your portfolio recently? Robert Boyda: So structurally in our glide path for Target Dates we are structurally more tilted toward equity, and that’s got to do with the way we plan and design and the way the outcomes are expected, and the way you want the final outcome. In terms of accumulation and the variance on that accumulation, so you’ll see particularly, what I call the belly of the curve, for the employees aged 27/30 to say 45/50, percentage wise there tends to be more equity in our portfolio. So we start with that as a baseline. Given that, our asset models have been more heavily tilted toward equity since 2011/2012. And we’ve enjoyed this wonderful run along and having seen the fixed income markets not perform particularly well with perhaps some exceptions in high yield and credit, we like that positioning. And we still like that positioning going forward, it’s just the tilt and the direction of where you’re taking the equity that’s shifting more to the non-US, more to EM, more cyclical exposure. And then in the near dated funds where you’re having more retirees, we completely agree that they’re getting more defensive. And there the challenge is can I find segments of the market that are not overpriced, still pay a big dividend, still focus on income, have stable businesses, which is, I think the thing that gets left out of the discussion. We talk about stocks that are low volatility. I think that’s a misnomer. I think you have to look through to the companies and say, “Are the businesses fundamentally stable, highly repetitive sources of income?” Those are the things you want your clients, particularly as they move close to retirement, to be engaged in. So yeah, we’re still overweight equity, although it’s fairly modest. We’re short duration on credit and short duration on fixed income, especially in the near dated portfolios where we’re more defensive. Michael Bapis: One other thing that’s important to note relative to that point is, the valuations on the S&P 500 are roughly only 100 stocks that are driving it higher, 100 companies that are driving it higher. There are roughly 400 companies that are much more reasonably valued. And that’s why we believe in an active management role, in an active management portfolio, there is value and there is upside. Last year, two years ago we saw the fangs that everyone was talking to, drove returns from being down 6 to up 8, it’s a similar situation where the majority of the S&P 500 companies are trading at roughly a discount or in line with historical values. And I think that’s important to know. Gillian: Yeah, very important point, and Jody, lastly, same question to you. How have you looked at the weightings between fixed income and equities in let’s say the recent time period? Jody Jonsson: So, we generally make asset allocation shifts very gradually within our series. And they typically are happening in the underlying funds themselves as opposed to at a top-down level. I would say on the fixed income side we have generally shortened duration because we were anticipating interest rate increases. A year or more ago we made a very active decision to get more engaged with inflation-linked bonds and TIPS. We felt like that was insurance that was essentially being given away for free. And so we put some of that protection into our portfolios. On the equity side we have maintained our fairly high representation in equities. But then again, as our series comes to and through retirement, the character of the equities changes significantly. And so we go from growth-oriented equities into more defensive and income-producing, within those categories we still find lots of opportunity. We don’t find that dividend-yielding category overvalued. We still find a lot of companies that are continuing to raise dividends. And to your point about stable businesses, that’s really what we’re focused on — not whether stocks are bond equivalents or not, but whether the business is sustainably generating cash flow to produce those dividends in the future. Gillian: And that stability you just alluded to is quantitative. But I would imagine there are some qualitative factors as well that you’re evaluating there? Jody Jonsson: Clearly. I mean, we’re very focused on managements and their strategies for the business and their long-term approach as opposed to just short-term things they can do to please shareholders. Gillian: Okay. Perfect. So we have some sense of your macroeconomic picture. Let’s move over to demographics, obviously incredibly important when talking about Target Date Funds. And, Michael, I’ll start with you, we’re living longer, our assets not necessarily. What are you seeing in terms of the demographic and longevity risk in the market today and how your clients are approaching it? Michael Bapis: Obviously demographics are changing quite rapidly especially today. We have the millennial generation which everybody talks about. But you also have a lot of people moving towards retirement. Retirement used to be 55-60 year old, now retirement, people are living 75, 80, 85, 90, however many years they are living. So while previously we thought that retirement was let’s say 20 years away from, you would need money for the next 20 years after 59½, there’s a possibility you’re going to need it for 30 or plus years. So I think that changes the way we allocate assets in our clients’ portfolios. And it definitely changes the way assets are allocated relative to like 40(k) plans or retirement such plans, where when you need to start taking those distributions, you want the risk to be minimized as you get closer to 79½. Gillian: Do you find that your clients are saying that they’re going to be working longer than perhaps they were before? Michael Bapis: Yes, working longer and worried more about having enough money to retire. I mean I think that’s … when you see a lot of the surveys done out there, that’s one of the biggest issues, people internally ask themselves, will I have enough money to retire? And I think they’re working longer and they’re more focused on their portfolios because of that exact phrase. Gillian: Okay. So client mind shifts are definitely happening. Bob, tell us a bit about how you look at this increasing longevity risk among Target Date Fund participants. Robert Boyda: So one of the biggest shifts I think we have all seen is this paradox of thrift coming absolutely clearly in focus. The generation that is now approaching retirement, having seen low interest rates as a sign and symbol of economic uncertainty, are now beginning to question the old assumptions that we had as economists, market participants, that if you lowered oil prices and you lowered interest rates, consumption would pick up. And it hasn’t, it’s been stable. And we think this is the new consumer, the demographic, the baby boomers hitting retirement are now much more savings conscious than they’ve ever been. And it shows up in all of the statistics. Good news for our industry, because it does mean they’re going to continue to save assets in that red zone between 55 and 65. They are going to work longer. They are going to spend their money differently, I also believe, in that period they’re going to be staying in their homes longer, looking to purchase and acquire more services. And they’re going to get very focused on their expenses, rather than try and squeak one or two percent more out of their portfolios, they’re going to look at a 100 things that they buy and see if they can’t squeeze their expenses down by one or two percent, because those are easy returns too to get out of your capital budgets. So that tendency now is also let them look around and say, “My heavens, my parents are living a lot longer, my friends parents are living a lot longer, I’m going to live a lot longer.” And it has changed the savings behavior. It’s changed the outlook, and I believe as I go to have those discussions that you’re having with your clients about longevity, they’re also going to be keeping their equity allocations much higher. They’re going to say, “This portfolio has to last 30 or 35 more years. By definition, if I thought it was a good idea to be equity heavy before, it’s the same now because I have that long duration.” And I believe that they’re looking at those capital market solutions, I think they still would like to find other solutions, more guarantees, they’re just not there. They look around the globe, safe income, government guaranteed income that will defease a liability, the likes of which they think they have, it just isn’t there. Ask any corporation, who’s paying and plowing money into their pension plans, they know it too and they think the consumers is starting to figure it out. And they’re changing their behavior right now, saving more, and I think that’s the trend for the next 30 years. Michael Bapis: And I think given the volatility over the last 15 years, the baseline for fear has kind of increased. I mean people are much more nervous coming into portfolios, they’re much less aggressive and we haven’t forgotten what happened in 08 and I don’t think we will for a long time, while it’s seven years past. And if you look back in 03 in 2000 there were bubbles that burst then too. So I think the baseline for fear is higher, which changes the way people think about their portfolio to a more conservative allocation, but they want the returns of equities. Robert Boyda: They do. You know, what’s remarkable is even today as we sit here, the consumer confidence numbers post election went through the roof, so did the uncertainty numbers. So if you add the two of them together you’re actually in a worse position today than you were post election, it’s just everyone’s confident, they just don’t know what they’re confident about. They think things are going to get better. And I think US equities are probably trading up on some of that as well. You know, the great hope for tax reform, the great hope for tax cuts, is being priced in. So I would say also to those clients that, “If you’re not participating today, you may be still as we always say, missing those opportunities.” Because it’s time in and the relentless compounding of wealth that they really need to focus on. And I worry that the uncertainty factor gets in the way of them participating. Gillian: Sure, Jody. Jody Jonsson: I think people are very focused on needing to both build and protect wealth. I think maybe 10, 20 years ago we could just talk about buy and hold and you could put it away and forget about it. And the events of the last decade have made people very, very sensitive to downside risk. We certainly see in our investor base that lots of people arrive at retirement and they’re really not ready to retire. They need to continue to build that wealth well into retirement. And that’s partly why we designed our glide path the way we have with a higher representation of equities and in particular, dividend paying equities into and through retirement. I think people are extremely sensitive to the sequence of returns. And as we’ve seen, once you’re in the distribution phase of a retirement plan and you’re taking money out on a regular basis, you care a lot more about protecting your downside and having lower volatility. And, again, I think that was sort of academic for a lot of people until the financial crisis, and now it’s very, very real and people had to start taking things out of pension plans in 2008. So it’s certainly sensitized us in how we think about our glide path and how we manage all of our funds that are the underlying building blocks of our plans. Gillian: Well, Jody, I’m hearing two forces and I’m curious how you think about it. On one hand there’s this increased uncertainty that are making many investors afraid and not participating maybe to some extent. On the other side obviously if you’re living longer you may want to be more aggressive. Do you find that you’ve adjusted the slope of your glide path at all to respond to these two, sort of what I would appear to be opposing factors? Jody Jonsson: We have not changed the scope of our glide path to be more aggressive in the outer years. We still think it’s important to be protecting wealth as well as building it in that period. So we have changed the shape of our glide path to favor dividend-producing equities, more equity income, and more flexibility to shift between equities and bonds as the environment dictates. We have a lot of growth-oriented equities in the early years of our vintages, and we feel like that’s the period where people can tolerate the ups and downs and can really build the wealth. But then we want to keep shifting it so that while we’re building, we’re also protecting on the downside, the further people get past retirement date. Gillian: Perfect, that’s great. So now that we’ve talked about macroeconomics and demographics, I want to move a bit into plan design. So I’m going to pull up a quick graphic that I pulled from Morningstar. It looks at the growth of assets and Target Date Funds. And obviously you’ll see immediately that is growing and it obviously is becoming a more and more popular retirement solution. Michael, starting with you, when you are talking to clients who want to allocate to a Target Date Fund solution, how do you explain the advantages and disadvantages of the structure? Michael Bapis: It’s a great question. I mean I think part of this slide is due to more people participating in 401(k) plans. And a lot of the 401(k) plans have Target Date Funds. But what we try to do is ask them, “How willing are you to invest your time in the decision making? How much trust are you placing in us in the decision making?” And then we create a portfolio that is structured around that, that thinking of the client. People that just want to forget it and put it on autopilot, they aren’t engaged in our decision making, that’s probably the extreme of the Target Date Funds. People that want to be more active, want more active management; want more flexibility, so we dial that Target Date Fund down. But as people get closer to retirement and as they get closer to let’s call it 70, our allocation increases to the Target Date Fund, especially in the 401(k) plans and the retirement plans that we’re managing. Gillian: Okay. So an advantage of the structure would be that the less that you want to be involved the better, because you have someone who’s calculating decisions, changing based on how much longer you have left until retirement? Michael Bapis: Correct. Gillian: Okay, and then a disadvantage? Michael Bapis: I would say disadvantage is flexibility; you really don’t have the flexibility to make changes in the portfolio in that fund. It’s set it and forget it if you will. And I think with losing that flexibility, part of the active management enhancement that a lot of portfolios have with active management, you lost a bit of that. And a lot of the return that’s generated over the index, the indices, and over the markets is from active and management. So I think you become more index based in those funds. And I would probably say that’s flexibility, and that are the two biggest disadvantages. Gillian: Jody, how do you look at this? We won’t call it necessarily an explosion of assets, but certainly an upward trend, and how have you seen the industry change from when you began till now? Jody Jonsson: I think it’s a great thing for the plan participants. So many people were defaulting to cash or stable-value options that just don’t generate the returns needed over time to prepare people for retirement. So the most important thing is that the participants are invested and that they stay invested. As you said, the compounding over many, many years is probably the single biggest driver of what the outcome will be. But then, within the plan, having fewer decisions that the participant has to make, which keeps it simple, keeping the fees down, the cost down, and the beauty of the target date, leading to a point in the future that keeps them focused on their investment objective. I think it makes the participant less likely to try to swing around with the markets. And just really keeps them in there. I think longer term the chance to take different vintages depending on a person’s risk tolerance and their timeframe, again, just vastly simplifies the decision process as opposed to trying to choose among potentially dozens or hundreds of funds on a DC platform. Gillian: Okay, excellent, and, Bob, how do you see it? Robert Boyda: We couldn’t agree – we couldn’t agree more, that this explosion, and I’ll call it an explosion, is a function of two things. One, legislative, let’s face it, the plan sponsors don’t want to have to deal with the DOL. And so as a default option I think it’s a good worthy option. The second point I think was made that it simplifies everything. And we’ve had either Target Risk or Target Date Funds in our platform for 20 years, driven on the same principle, that people want simplicity. They have access to a lot of different options and they can in many cases get access to good information and good planning. But where the typical investor hits the road, you have an enrollment sheet, what do I do? Well, I have all these options. If they have confidence in the fact that this simple solution will help them along the way, stay invested. And quite frankly if you’ve geared your Target Date Funds correctly, you have very young people with very high equity allocations, relatively small balances if there’s some volatility. The next couple of allocations that they make are salaries and bonuses, whatever, will fill up the bucket and they’re going to feel like they’re actually accumulating real wealth. They get all the time value of money. They get dollar cost averaging, all of the wonderful things that we’ve said and hopefully, [they don’t pay it much mind]. And that behavior we’ve learned over time, not related just to capital markets, but to the behavioral aspect of defaulting into something, staying there and letting inertia work for us instead of against us. So in that respect I think the Target Date has been a wonderful innovation because it’s helping these people do exactly what we want them to, stay invested, number one. Number two, because it’s simple, I think they’re going to start to feel, certainly in the last five years, some degree of success. And as that word gets around the coffee room, my 401(k)’s growing, things are going well. I am actually producing some real money here. You’re going to get more allocations; people are going to take a more serious look. And I talk to the millennials all the time, they’re really focused on this idea of saving for retirement, they’ve got it. Now, I don’t think the boomers have. But the millennials are going, you know, “Look, I’ve got 40 years to accumulate a pile of money that’s going to last me another 40 on top of that. That means I sort of have a dollar for dollar.” It doesn’t say very much about their view of how much they’re going to accumulate over that period of time. But they get it and so all the education and the processes have really helped. The simplicity I think is what’s giving that glide path, that explosion in the assets that you pointed out from the Morningstar research, its lift. Michael Bapis: And it also helps corporate culture, we’ve found. If people and employees are comfortable with their 401(k) plans and with their allocation, the principals of the firm are more at ease because of the regulations that you mentioned, and the employees are more at ease. I mean I think it … we’ve seen it in a lot of the 401(k) plans we manage, with … the employees are happy about their 401(k) plan and about their Target Date Funds, they’re going to be more willing to be loyal to that company. Robert Boyda: We have plenty of evidence studying our own plan participants; about how much more productive they are as investors. So we have segmented them by demographic, so by age, by risk tolerance and looked at their allocations. And said, “Okay, as an aggregate, we’ve got this group that are more or less balance fund investors and they’ve taken a one decision fund, like a Target Date or a Target Risk Fund versus a do it yourself. And the deltas over 10 and 15 years are in the neighborhood of 150/200 basis points. It is very difficult for most active managers to get that kind of delta. Here you’re talking about behavioral alpha. And that helps them, and I couldn’t be happier about the industry going down this path. Jody Jonsson: It takes so much stress off the participant of having to make that decision that they’re not really equipped to make. And many of them don’t have financial advisors to help them. So it spreads out their risk, diversifies them both at a point in time and over time. And, as you say, it’s about the simplest decision they could make with the best outcome for their future, the sort of risk-reward to that decision is just very much in their favor. Michael Bapis: And the only calculation they’re making is their age. And they say, “Okay, this is how old I am, this is the number out there, let’s go with it.” Gillian: So hopefully they don’t have to calculate, [inaudible]. Robert Boyda: [Inaudible] and away you go. Michael Bapis: And the age of retirement, so yeah. Robert Boyda: And the key for the design people, for us is to make sure they’re engaged the entire way, that they feel that there is an accumulation happening, and that they feel somehow it’s adequate, that it’s not too volatile for their age, and for the size of asset that they put in. And so when we get to design, you can sort of pull a glide path off the shelf. But I think the more thoughtful designs that actually look at, well, we don’t know when the participant is going to come in. We don’t know how many dollars they’re going to put. And can I optimize that glide path so that everyone is treated to the best possible outcome at every single point, regardless of how much money they bring into the program. And that I think is the genius of, you know, we all have the gear heads back in the shop in the closet somewhere, cranking out numbers and testing the glide paths, and why you have to go back at it at all times to see whether or not you still have the right design. Jody Jonsson: I think that’s an important point. I think as the industry evolves it’s not … we’re past the point of getting people invested. And now it’s much more focusing on investor outcomes and objectives and delivering a result for the client as opposed to just beating a benchmark or, you know, being in an asset class. It’s really about delivering the best possible outcome, whether that is protecting on the downside or taking income in retirement or, through active management, delivering more money at retirement, which is a very important aspect of active management. I’m happy to see the industry moving more toward focusing on the participant outcome. Gillian: Let’s stay on the DNA of the glide path for one moment. Obviously we have two schools of thought when designing a Target Date Fund, to versus through. What have you chosen? Jody Jonsson: We have chosen through, because of the point we’ve already made about people not really being ready to retire at retirement. We think that you both need to build and protect wealth in retirement. So we want to continue to compound past that retirement date. But we want to protect it so that it’s less volatile if market corrections happen from that point on. So ours is 30 years through the retirement date. And particularly for participants who may not have a financial advisor, who stay in the plan, that’s really taking care of them beyond that retirement date. Gillian: So longevity obviously impacting that decision. Jody Jonsson: Very much a factor in our decisions. Gillian: Bob, how do you look at this, to versus through? Robert Boyda: We’re a provider of choice. So we have both. And in the creation of those glide paths we had to ask some very difficult questions. We ended up in exactly the same place, on the through glide path. It says, yes, I’ve got, longevity is the biggest risk. The to glide path was responding to a lot of participants came to us and said, “We think your glide path in the early days is too aggressive. We would like something a little tamer. We need to keep up with the capital markets, we’re not really focused on beating everything. We don’t, it’s not the maximum accumulation. And boy, when you get into that 10 year red zone, and the planning starts, I want to be able to take my statement home to my spouse and say, I’m pretty sure in the next five years that this is stable and we can start planning.” So the last five years of that program becoming virtual absolute return strategy. So you’re hoping for something better than bond market and even in the case of rising rates, you want to still protect those assets. So there’s a clear line of sight on the retirement plan. And then the expectation is they take their money at that retirement date and go see their financial planner. So the objective function for that glide path was, when equity markets are roaring you have to stay close to the pin. So I want to stay near the middle of the pack, when everyone else is taking, you know, whose are the more aggressive glide paths, I want to stay close. And then in that last five years, I want to be the one that you come to and say, “Boy, I’ve got the comfort solution for you.” Jody Jonsson: And you’re talking about an investor objective, right. It’s not about beating the market anymore at that point. It's about preserving that wealth and making sure that they then roll it into the next appropriate vehicle. Gillian: Michael, do you find that when you're evaluating these funds you tend to prefer one versus the other? Michal Bapis: I think it's a combination of both. I mean we evaluate the risk tolerance of the client, and then one of you mentioned absolute return, you know, it's not always beating the markets, it's what can you get as a reasonable return based on your risk tolerance. And I think which you mentioned too the date of retirement, while it's going to go through that date, assuming you live for the next 20/30 years, it's a combination of both, get there and then after you get there, what changes in your goals, probably your income goes down. So maybe you structure a more conservative portfolio, but I think it's a combination of both to it, and then after it, what are your goals. Gillian: Okay. Bob, you employ an open architecture in your Target Date Funds, can you tell us more about why you've chosen to do that? Robert Boyda: That's a great question. So we love open architecture, and when we look at the structure of 401(k) plans it became for the next 20 years pretty much an industry standard that we open architecture the entire plan. Because as well as a lot of active manager do, they have strengths and they have weaknesses and across their complexes they have brilliant investors and they have start-ups and they have the full spectrum. And so we've had this large multi-manager platform for the better part of 20 plus years. We've got sizable assets with these folks, and so we're able to deliver the multi-manager open architecture experience at a very competitive, sort of single manager type of price. And that's a great combination. We think it fits within the structure of the way 401(k) plans are evolving in their design. We think it's right for the investors. We also think that as we look at active management and have the ability to pluck dividend strategies or sector strategies or emerging markets strategies where I can differentiate between a conservative EM and a broad based EM. Having that flexibility within the designing construct gives me a lot more flexibility in how I shape those outcomes, because I can simply go and find what I perceive to be at that time, the best active managers for that particular type of role. So we love the active manager space, very committed to it, very committed to doing it on an open architecture basis. Gillian: Okay, interesting. Now, Jody, obviously you employ a slightly different structure, you're looking at internal managers, explain to us why you've chosen that particular style. Jody Jonsson: So we use only our own funds in the construction of our glide path, and that's because we know our own funds better than anything else out there. Our Oversight Committee that constructs the Target Date glide path is made up of seven managers who are all managers in the underlying funds. And so we know them inside and out, many of them have records dating back decades; our oldest fund is 80 plus years. So we've seen how these funds perform in different market environments. And we feel we have the best data possible in terms of knowing how they will correlate with each other, how they will behave in interest rate environments, stock market cycles, etc. So we feel like we couldn't possibly know anyone else's funds as well as we know our own. We're always looking for whether we should enhance it by adding capabilities that we don't have. But we have a fair amount of flexibility within the funds to go between equities and bonds or US, non-US as we've discussed, to hedge currencies for example. We've added some enhancements around things like inflation linked bonds, and mortgage securities, asset classes where we felt they would be complementary to the existing series, but for reasons of transparency, cost and simplicity, we've just chosen to stay with our own funds. Gillian: You alluded to the data that you were looking at, can you share some of the metrics that you're evaluating when allocating across your various funds? Jody Jonsson: So we make relatively few changes, but we're always evaluating. So we are looking at the results of the funds in different market periods, particularly whether the Target Date Funds are behaving as we would expect them to behave, say, in a down market. And if they don't, then we obviously ask ourselves why. We're always looking at the building blocks of the funds to say, “Maybe we should have a bit more in this one versus that one.” We look at risk-return trade-offs. We look at correlations among the funds over time. We even look at the manager level within the funds to just make sure that everything is as it should be. Gillian: Staying on this due diligence front, Michael, when you are selecting a Target Date Fund solution, how do you evaluate across firms and offerings? Michael Bapis: It's a great question. I mean we put a lot of work into that, our firm was founded on the principles of open architecture, we really don't have internal funds. And so, much of what we do on a daily basis is evaluate fund managers, our quality job control is advice. Are we giving our clients the best advice? And so we spend a lot of time with the managers, I like to, you know, there's a qualitative aspect to it face to face with them. Top quartile matters, flexibility matters, sticking to a discipline is a big, you know, we look at that, probably as closely as anything to sticking to their discipline. And at the end of the day, they have to perform, and we have the luxury at HighTower to be able to select the top quartile highest quality managers, evaluate them on a two, three, four, five year basis, and let’s stick with them for the duration. Gillian: So just as you’re evaluating asset managers, Bob, obviously you are selecting managers from other firms to put into your Target Date solution, so how do you evaluate managers? Robert Boyda: We have multiple layers of that discipline to select managers. So the first layer is an entire functionality that I helped install into the organization some 20 plus years ago, on how to do manager due diligence, how to sit with a manager and ask questions. And over the course of three, four, five years, get to know them, get to understand their philosophies, their principles before you start allocating money. That discipline built up over all that period of time is now part of John Hancock Investments, Investment Management Services Group. My team is a whole different level, so we think of ourselves as the investor class. so it's not just that I have access to the managers and I've got full transparency, and I've known many of these managers for 20 plus years. I've got a really good insight into, you know, whether or not they're having a good day, bad day, bad week, month, year. How that strategy is supposed to behave based on their metrics, just based on the amount of time that we've been in business together. And they are … the way our structure works, they are sub advisors, so the funds are ours per se, they go under our banner. It's just that the sub advisor is the differentiator. And we have access to all of their holdings, from my team on a lagged basis, but from the Hancock Investment side, on a daily and ongoing basis. We certainly know what to expect from all of the managers based on their performance profiles. And it's those profiles that help us craft the kind of solutions that we want. And if we're not getting the solutions that we want or we need, we can always reach outside and say, "Hey, is there someone else?" And then teams of people who are scouring the universe both at the John Hancock level and at my team level, are looking for additional capabilities. And so one prime example would be what do you do in absolute returns space? Where we've had currency strategies, you know, long/short currency, or global TAA, Tactical Allocation where you look at venders like Standard Life, who have got this long history and pedigree of producing cash plus five, and that's a good bond substitute. Can I leverage that inside of my Target Date structure because I'm going to have low expected returns and fixed income? So we can go and find those people and bring them in. and that's why after sufficient due diligence, time in, and getting to know what the performance profile is like, that we get more comfortable with the open arc. Gillian: Jody, everyone loves to talk about fees these days, are we in a race to the bottom? Jody Jonsson: I don't know if we're in a race to the bottom, but certainly the pressure on fees is downward, and that's a good thing for the investor. We are among the most competitive active managers on fees. And we also benefit from break points in the underlying funds, so as the funds grow, the fees come down. We think fees are one of the most important things about Target Date retirement plans, but not the only thing. And I do think that fees have become the talking point at the expense of returns and investor outcomes. Just on this trip that I'm on this week we're meeting with target date clients, and I'm just amazed at how much discussion there is about fees without considering what you're getting for that fee. Gillian: Yeah, it's a great point. Michael, when you're looking at fees, how do you think about what's worth paying for? Michael Bapis: Look, people will always pay for good advice. So the quality of the advice and the quality of what's behind the advice is where we spend most of our time focusing. It's just like any other professional you go to, whether it be a doctor or an attorney, or whatever it may be, if they put out quality work, the returns justify the fee, they'll pay the fee. And so I think there's a lot of conversation around it. But part of what you mentioned is it’s because of the returns. Because of returns are suffering, because anxiety's rising, people are saying, "Well, why do I need to pay this fee?" And we are in an environment where passive management has outperformed. And at any time you see that happening, people are thinking, well, why do I need the active management? But that's probably the time that it turns right back the other way, and people go from active to passive at the wrong time. Jody Jonsson: And passive has outperformed the average active manager, but not all managers are average. Michael Bapis: That was my ... well, you're right, and top quartile managers. Jody Jonsson: Some active managers have delivered significant outperformance, and that's worth paying for. And that's why I feel like the focus on fees gets too shortsighted. Look at fees in the context of results and investor objectives again, investor outcomes. Michael Bapis: and absolute return. You know, we went in to get this return; we're getting higher than this return, because of the quality of the manager. The fee shouldn't be affecting our conversation and where we see the future of our investment. Robert Boyda: I would also like to lob one correction into this dialogue, and that is that people have said, active has trailed passive. Well, it has in US large cap core among the average managers, you get outside of that in mids, small is where the coverage is terrible, go international, go international small. And find those asset classes where coverage has disappeared completely. The ability to add value there, viz-a-viz an index is huge. So yes, if you're comparing the most efficient, effective, highest most perhaps overpriced index in the world, the S&P 500 against the rest of the complex, yeah, there's been, you know, the momentum guys in the S&P 500 Index of one. But you get down into the less efficient parts of the market. And then don't even get me started about fixed income, because there the average manager has thumped the index. And then, you know, the passive people try and jigger it around by saying, “Well [on a record job].” No, they've done a better job, it is a less efficient market, even though it's much bigger than equity, and they've done extremely well. Jody Jonsson: And the passive bond manager can't adjust: can't shorten duration, can't anticipate a rising rate environment. Michael Bapis: And the simpleness of access to issues, the passive manager can't access or assume a new issue like an active manager can, so in fixed income. Robert Boyda: And we always assume that in some ... especially the global benchmarks for fixed income that after all the alpha's been extracted, and the fund is gone, then the passive benchmarks start to accumulate interesting assets. And I'll give you an example, we think there's a huge opportunity right now where people need capital, and they're still paying for it, and that's in Southeast Asia. So as part of our flexibility, we have dedicated allocation to Southeast Asian fixed income. That will become part of the benchmark, as will China become part of the benchmark, in at least two or so years, after it's all been normalized and the opportunity has gone. So why can't we simply get ahead of that with intelligent active management. And I think fixed income is full of those opportunities and so we're a lot ... I'm a lot happier about active outside of the US large core. Gillian: Bob, you have both active and passive strategies available at your firm, can you give us the differences in how investors are approaching fees, and what you see coming down the pipeline? Robert Boyda: So there is definitely a class of investor out there, plan sponsors who are simply fee focused. And for them the requirement to even get to the dance is to have very, very low competitive fees in the passive area, and fee for value in the active area. And so what we've chosen as a vendor is to say, “Well,’ we have both, you choose.” The glide paths are highly similar, the implementation is different, and so are the coloring and the shading that we can do in the active space, those opportunities are not available to us as readily in passive. And certainly you know, we think that there are some compromises on the passive side, that said, you know, the delta in fees is fairly significant, you know, in a land of 20 or 15 basis points for a multi asset, multi global portfolio, you know, 20 or 30 basis points to move up to active, to some people seems like a lot. And so we offer them both suites and say, “Mr. plan sponsor, it's up to you to decide, you know the benefits and liabilities of both.” Gillian: Okay. Before we end our discussion, because we're actually coming close, I wanted to bring in a viewer question that was submitted to us about Target Date Funds, it looks forward to the future and asks you a little bit more about how you see the future of your business going forward. Gabriel: Hi this is Gabriel from Westminster Consulting. Imagine you had an unlimited budget for your research and development plan, what enhancements would you like to see in your Target Date series? What improvements would you like to see your peers embrace? Gillian: Michael, I'm going to start with you, as you are evaluating Target Date Funds, what do you want to see in these providers that you think might be coming down the pipeline, or you can give us some audacious dream that you have for it, whatever you prefer? Michael Bapis: I think the number one is quality of management. I mean it's important to have the right managers in there, the right absolute return managers. We look a lot at that. And then if I were to say what more could be done, is add flexibility to it. Add flexibility based on if something's not outperforming, or if a manager's struggling a little bit, do we add a little bit to that manager because we know that they're going to come back, or do we mix it and move into another manager? I think the biggest issue for us, we see with Target Funds is the lack of flexibility. And so I think we would try to enhance the flexibility more. Gillian: Okay, so more flexibility. Jody, you have an unlimited budget, what would you do to enhance your Target Date series? Jody Jonsson: I do think that the industry's going down the path of becoming more customized over time, although — and we are looking at that as well — but I don't think there's, while there's a lot of technology around it and a lot of thinking about it, I don't know that there's really a good solution yet. I think we and many others would like to focus on retirement income orientation as well. We have launched some retirement income funds as a supplement to our series for those who want to start taking distributions at retirement. But I don't think anyone has really yet cracked the code on the perfect retirement income solution. As far as what I would like to see the industry do, I think it would be good to be focusing on volatility and investor outcomes, as we have talked about. That again the path of that return for the investor into and through retirement is very important, particularly once they're taking distributions. And so I think the industry focusing on the investor objective as opposed to just the benchmark would be good for all participants involved. Gillian: Okay. Bob what does the future look like? Robert Boyda: So I have three things. Number one would be this diagnostic tool that connects the glide path with the expected outcome. A better way to see whether or not the glide path that you've created and the way you've allocated your assets is in fact delivering the value proposition that you created for your client. Now, it's complicated because you have assets spread out all over the world, you have different shapes of glide path, you have different potential outcomes. And everyone's saying, “Well. it's just, it's a performance, or it sharpe ratios.” Or it's some other sort of standard metric that doesn't take, well, what did you try to design for and can I connect that back up to how you actually designed it? And make that tool broadly available so that everyone can see it, and they could say, “Yes, you are doing exactly what you said you were going to do, in exactly the way you said you were going to do it, and therefore I have higher confidence.” And so that would be number one. Number two sort of related to that would be the ability to pass some of that unlimited budget back to the shareholder so you could say, “Yes, if it was in fact unlimited, everyone could share the wealth and find better ways to lower the cost, or improve the perception of value.” And that means the industry has to align behind this, and what is value as opposed to just a cheap price. And I don't think we're there and I think some advertising and some work needs to be done around that metric. Finally, and this is my complete and utter dream imagination, is that FinTech, the guys working in Silicon Valley, finally figure out how we can do individualized glide paths. So as your life changes, and you have events, spouse won a lot of money, spouse has a pension plan, babies come, you know, inheritances come. That necessarily may change the shape of the glide path for you. How do I do that? I think the robos, the FinTechs are working on those things, I don't think they're quite there. So if I had an unlimited budget, I would probably spend it there, seed a whole bunch of folks and say, “Here, find me the ideal outcome on a per person basis, the ultimate in individualized glide paths.” Gillian: Great well thank you so much for taking the time, not only to share what's going on in the present Target Date Funds, but to give us a little bit of a look into the future to hear where the industry is headed. So we appreciate you coming in and joining this addition of master class. And thank you for tuning in. From our studios in New York, I’m Gillian Kemmerer. This was the Target Date Fund Masterclass. Definitions Alpha measures a manager’s incremental return that cannot be attributed to market movements. Beta measures the sensitivity of the fund to its benchmark. The beta of the market (as represented by the benchmark) is 1.00. Accordingly, a fund with a 1.10 beta is expected to have 10% more volatility than the market. Sharpe ratio is a measure of excess return per unit of risk, as defined by standard deviation. A higher Sharpe ratio suggests better risk-adjusted performance. Cash plus 5, in general, is an investment strategy that seeks to outperform a cash proxy, such as treasury bills, by 5%. Delta is the ratio of a price change in a specific asset to the price change of its derivative. If an option’s delta equals 0.5, this means that a $1 increase in the price of an asset will result in, ceteris paribus, a 50 cent rise in the option price. The opinions expressed are those of the presenter at the time of the recording and are subject to change as market and other conditions warrant. This is provided for informational purposes only and should not be construed as a recommendation or endorsement of any security, investment strategy, mutual fund, sector or index. No forecasts are guaranteed and past performance is no guarantee of future results. The information is based on sources believed to be reliable, but does not necessarily reflect the views or opinions of John Hancock Investments. The S&P 500 Index tracks the performance of 500 of the largest publicly traded companies in the United States. It is not possible to invest directly in an index. Past performance is no guarantee of future results. All investments involve risk, including the possible loss of principal. Investments in Target Date Funds are subject to the risks of their underlying funds. Each Target Date Fund’s name refers to the approximate retirement year of the investors for whom the portfolio’s asset allocation strategy is designed. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in a Target Date Fund is not guaranteed at any time, including on or after the target date. For additional information on these and other risk considerations, please see the fund’s prospectus. Diversification does not guarantee a profit or eliminate the risk of a loss. This material is not intended to be, nor shall it be interpreted or construed as, a recommendation or for providing advice, impartial or otherwise. John Hancock Investments and its representatives and affiliates may receive compensation derived from the sale of and/or from any investment made in its products and services. Clients should carefully consider a portfolio’s investment objectives, risks, charges, and expenses before investing. The prospectus contains this and other important information about the portfolio. To obtain a prospectus, call John Hancock Investments at 800-225-6020, or visit our website at Clients should read the prospectus carefully before investing or sending money. Information and opinions contained in this interview have been arrived at by American Funds. American Funds and Asset TV Inc. accept no liability for any loss arising from the use here of nor make any representations as to their accuracy of completeness. Any underlying research or analysis has been procured by American Funds for its own purposes and may have been acted on by American Funds or an associate for its or their own purposes. HighTower Advisors, LLC is a SEC registered investment advisor. Securities are offered through HighTower Securities, LLC, member FINRA, SIPC and MSRB.