MASTERCLASS: Retirement Solutions Fit for Purpose

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  • 48 mins 22 secs
Retirees face several headwinds in making their income last, which is why it’s critical to be able to identify solutions fit for purpose. A panel of target date specialists shares three tips for evaluating different strategies in order to meet the needs of a wide range of individuals.
  • Kathryn Farrell, CFA® Portfolio Specialist, Multi-Asset Division
  • Andrew Jacobs van Merlen, CFA® Portfolio Manager, Target Date Strategies
Channel: T. Rowe Price

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Jenna Dagenhart: Hello and welcome to this exclusive masterclass with T. Rowe Price. Retirees face several headwinds in making their income last, which is why it's critical to be able to identify solutions fit for purpose. Here with us today to share three tips for evaluating target date funds, it's an honor to introduce our speakers from T. Rowe Price. Kathryn Farrell, Portfolio Specialist, Multi-Asset Division and Andrew Jacobs van Merlen, Portfolio Manager, Target Date Strategies.

Jenna Dagenhart: Kathryn and Andrew, it's great to have you both with us. Retirement needs are constantly evolving as we know. Setting the scene for us, could you elaborate on some of the challenges and risks that people face as they prepare for retirement?

Kathryn Farrell: Absolutely. Thanks so much for having us, Jenna. We know a lot about participant behaviors, both the challenges and some bright spots. When we look across our recordkeeping platform, which houses almost two million participants, we generally see that savings rates are too low. And that's really the same across the lifecycle, but even more so for younger workers. So, those that have multiple decades to prepare for retirement certainly aren't starting to think about it early enough and saving enough so that they get that meaningful account balance by the time they hit retirement age.

Kathryn Farrell: Also, we see that generationally, life expectancy is increasing. So, individuals that are 25-year-old today are expected to live multiple decades past age 65 or through retirement. And they have a higher probability of reaching those extended life expectancies than someone who's aged 45 today or age 65 today. So, they really need to think about how are they going to build up those assets and make them last.

Kathryn Farrell: Younger workers are also more likely to depend on defined contribution plans or retirement plans than a defined benefit plan that would guarantee some type of income. So, they need those assets that they're saving to really last a long time.

Kathryn Farrell: At the same time, we know that retirement needs aren't an exact science. There isn't a specific dollar amount that each individual knows that they'll need throughout their entire lifecycle. We know that retirees are likely to experience spending shocks or have an unexpected expense crop up during that phase of their life cycle.

Kathryn Farrell: And also, the components of retirement spending that are the biggest proportion of the spend, housing and healthcare, the costs tend to go up more than the average inflation. So, that's another challenge to think about in terms of how do you really get that meaningful balance and have that last throughout retirement.

Kathryn Farrell: So, also we know that when you think about the risks or the tradeoffs, it can be nuanced as well. There's a lot of focus on market risk. I think and the industry people tend to think about the way that the market moves, how it goes up or down is the main risk when you're investing. But when you think about retirement investing, it's a little bit of a different tact. We do a lot of work with plan sponsors, asking them what risks they're trying to solve for and how do we help prepare retirees for retirement and participants to go through their work in years and retirement.

Kathryn Farrell: And when we ask plan sponsors, "Well, what risk are you trying to address," we typically hear that longevity risk is the first one that they rank. So, if they're selecting the hierarchy ranks in terms of risk, longevity risk, or the risk of running out of assets, it's really top of mind. And I think that makes intuitive sense.

Kathryn Farrell: If you're offering a retirement plan, you're trying to get your employees to save part of their paycheck to build up a nest egg of assets and then how those assets last for decades, the risk of not having enough money when you retire or not having your assets last throughout retirement is a real headwind. That's a real challenge that we want to be able to face and help plan sponsors and help the participants manage that.

Kathryn Farrell: We know that there's other risks that can't be ignored either. So, when you think about things like downside risk, or behavior risk, or volatility risk or inflation risk, those are also important. But the ranking and the consideration in terms of the spectrum of risks do vary. And so, I think that's important for plan sponsors to recognize, too, that participants are facing challenges. There's a lot of risks that they'll have to navigate. But how do you decide what's the most important thing for you to address when you're offering a retirement plan and when you're selecting a target date strategy specifically?

Kathryn Farrell: Plan sponsors have a lot to think about. It's certainly not an easy task. But the decisions that we make now today can help set retirees and set participants up for success over the long term. And so, again, it's important to really have the foundation of what we're trying to do, what are the considerations, and that helps to build a framework for going through this process to select a target date to oversee it, and to get really get participants to a successful outcome over this lengthy time horizon.

Jenna Dagenhart: How can we set up plan sponsors to think through what's needed when selecting a target date strategy?

Andrew Jacobs v...: Sure. So, what I would say is the first step is really to start thinking about what are the key inputs in that overall selection process? And when I step back and think about it, I think first and foremost, it's about being clear on what you're trying to solve. So, what are the intended objective of your defined contribution plan? And ultimately, if you think about that broad reaching question, it can be kind of daunting at first, but I think you can start to narrow down on the answer by answering some pretty simple questions.

Andrew Jacobs v...: Things like, what's the main problem you're trying to solve. So, Kathryn was just talking about that focus on longevity for many of the plan sponsors, sort of think about what's the position you want to retirees to be in when they reach retirement? And then again, thinking about what's that spending replacement need? What's the goal of this plan and how reliant will participants be on these defined contribution assets to get to that lifetime income goal.

Andrew Jacobs v...:  And so, once you start to understand kind of the range of risks that participants are facing, it's really about kind of the tradeoff between those different goals. And it becomes an exercise of prioritization. I think Kathryn just said it. It's really kind of determining that hierarchy of needs in terms of each goals relative importance. And so, it's about what are you most concerned about? And how does that impact ultimately what you're trying to achieve.

Andrew Jacobs v...:  And then I think the second step is really to understand what I call the kind of the facts and circumstances of your plan. You hear a lot of talk about demographics and savings rates. But really, to me, this is kind of the data. And so, when you look at those demographics, you have to start thinking about how could those ultimately influence your choice of solutions. And so, when you look at plan level characteristics, you start to look at kind of savings trends. You use this kind of to project income needs into retirement and it starts to become this exercise of kind of assets versus liabilities.

Andrew Jacobs v...: So, you're ultimately starting to kind of narrow in on that picture of potential outcomes for your retirees. And it's not too dissimilar to what you'd see in a defined benefit plan. So, looking at kind of what are your projected assets versus your projected liabilities and ultimately here, you're starting to basically look at how well participants are doing in that progression through the lifecycle towards those retirement goals.

Andrew Jacobs v...: So, I would say all else equal when you kind of take a step back. When you start to look at the data and the facts and circumstances, what you'll find is that the better funded a plan is or an individual is, the less need they'll have for growth assets in their design to help them achieve those same retirement objectives.

Jenna Dagenhart: What about participant behaviors, particularly as they approach or start retirement? Are they keeping assets in plan at retirement or pulling them out? Or do they move to cash during market volatility? What do we know about how participants act and why does that matter in this type of evaluation?

Andrew Jacobs v...: So, behavioral aspects are clearly a factor that you should consider. I think you've seen some pretty clear changes in some of these. I think a lot of times, if you think about the debate of kind of designing target date strategies on to design versus through design kind of this fear that participants will ultimately leave the plan, what you see, in fact, if you look at kind of where the assets move, they'll often go right back to a similar allocation that when they left the plan.

Andrew Jacobs v...:  And so, what you've seen is kind of predominantly across the industry, you start to think about this, overall, this holistic lifecycle and trying to incorporate that into your design. So, clearly, things like how long participants stay in plan, that's going to affect your time horizon piece. So, you can manage for a longer horizon. If you look at things like trading, some plans have higher level of trading, higher self-directed investors. And that can ultimately impact kind of how you weight the emphasis on supporting lifetime income on one side, versus mitigating the effects of near term market volatility on the other side.

Andrew Jacobs v...:  And so, to me what I would say is behavioral aspects, they clearly matter, but generally speaking, they're not critical in understanding that that data, those needs of your participant. They're more likely to influence what I'd call kind of those preferences and objectives that you'll see for plan sponsors.

Kathryn Farrell:  A lot of the data that we see on participant behavior is encouraging. So, when we look at how participants using target date strategies respond when there's market volatility, it's really they do a really good job. They tend to stay the course as markets move up and down. And that's to their benefit. I think the fear is or the narrative is that if markets sell off and investor sells out of their investments, if they move into cash or pull their money out of the investment, that means they lock in their losses, and then they don't experience the rebound and their whole retirement will be derailed.

Kathryn Farrell: But what we tend to see is that target date investors are really stable. They don't trade as much in their account. They're not as likely to make an exchange to a different type of investment. And you can do it yourself, investors who generally stay the course. But when we look at targeting investors, they're generally four times more likely to stay the course when markets sell off. And that's really encouraging.

Kathryn Farrell: When we looked at the beginning of the coronavirus pandemic in the first quarter of 2020, we saw that 98.5% of target investors did not make a trade in their account. So, they stuck with their target date strategies as the market sold off very quickly, but then subsequently rebounded very quickly.

Kathryn Farrell:  And so, that's a good outcome for targeting investors that they continue to invest, they could, for example, dollar cost average into the investment and then experience the market rebound as it happens without worrying about trying to time the market and move their assets in or out of their investment. So, that's certainly encouraging. And I think that gives us a lot more conviction that that aspect of behavior doesn't necessarily have as much influence as those that Andrew mentioned.

Jenna Dagenhart:  Target date strategies are used by a wide range of individuals. How do you consider the entire plan population and how different decisions impact different cohorts?

Kathryn Farrell:  That's another great consideration. And it's really integral to target date design, and in particular, glide path design in the fit for a plan. Our second tip for plan sponsors if you're thinking about how can we help them create a framework and create a way to decide what type of target date is appropriate for their plan is to think beyond averages and to think about that entire population that you mentioned.

Kathryn Farrell: Designing a single glide path for a population is inherently a difficult problem, because there's a lot of diversity within a plan. There's a lot of heterogeneity among those characteristics that Andrew just reviewed, as an example. Salary ranges vary. Savings rates certainly vary by individuals. And so, when you're trying to design a single glide path, that can be a challenge.

Kathryn Farrell:  And the way that some providers attack that problem is to think about an average participant. So, they'll create this mathematical value that says the average participant makes X amount of money. They save 9% of their salary each year. That means they need so much in terms of the equity, and how that changes over their life cycle.

Kathryn Farrell: But the drawback of doing that is that they could be missing out on some of the needs of some members of a population, particularly those that are most vulnerable within a plan. So, I think an easy example is, if you look at the percentage of income that someone is going to be receiving from social security, the median amount is 41% of their income. That's going to be replaced by social security. But if you look at someone in the lowest earning quintile, they're going to get about three quarters of their income replaced from social security.

Kathryn Farrell: If you look at someone in the highest earning quintile, they're going to get only about a quarter of their income replaced from social security. So, that can be two different things in terms of their outcomes or their needs as they're preparing for retirement.

Kathryn Farrell:  Same things with savings rates, if someone is saving a really high percentage in terms of their paycheck putting away more money, that means they're not spending as much during their working career so they don't need to replace as much spending in retirement. And they're also giving themselves a head start in terms of building up that nest egg and getting a bigger balance, versus someone that's not saving enough or can't save enough, that's a challenge. And that means that they need their investment to work even harder for them.

Kathryn Farrell:  So, our approach to designing a glide path is to really move beyond that average construct and think about designing solutions that can meet that range of needs across a population. And so, I think maybe just to give another example, I think clothing manufacturers really get this right. When you think about going into a department store and you look at clothing options that are designed to be one size fits all, that's kind of the same as a glide path. It's one allocation that's supposed to be appropriate for that entire population.

Kathryn Farrell:  And if you think about the average male, for example, is five foot nine, almost 200 pounds. If you design a t-shirt that's going to fit that average male perfectly, that's okay for that one type of build or person, but what about people on the other ends of the spectrum? So, I'm five foot one, I'm almost 120 pounds, certainly going to be too big for me. But if I consider my cousin, for example, is six foot three, he's 300 pounds, that t-shirt isn't going to fit him well at all.

Kathryn Farrell:  So, when you think about, well, how do you design something that's supposed to fit all of us, you have to tend to err on the side that's going to provide a better fit for everyone in the population. So, you tend to design something that's going to fit that person that needs more clothing and he's a bigger size, that's going to fit okay. On the average person, it'll be too much fabric for me. But then I'll be okay in that size t-shirt. It will certainly cover me and give me enough coverage.

Kathryn Farrell: And when we look at glide paths and how to construct them for distributions of populations, where there are different needs, especially those on the extreme ends if you have any type of population, we tend to see that the best type of glide path for that fit is going to be higher equity. And so, that's going to give more growth to people that need it, so people that are under saving, the people that have really high income replacement needs.

Kathryn Farrell:  And we can actually model this. We use our framework. And we can look at how this actually comes to play by comparing two different glide paths, one that is designed for an average population, so really simplifying what a plan characteristics might look like and saying, I'm going to get average savings rates, average salary, average social security replacement, average preferences, so all the inputs and say, let's just pick that average.

Kathryn Farrell:  Versus you could use a distribution or a range or even a model for all of those inputs. And that gives you a more realistic representation of what a plan actually is like. It accounts for that diversity, that heterogeneity within a plan. And you can compare the level of equity between the two.

Kathryn Farrell:  And what we tend to see is, again, that glide path that's based on the distribution, that's based on that more realistic view of what a population looks like, tends to be higher in equity. And then importantly, we can also look at, well, what does that mean for outcomes. So, we can compare what the outcomes look like in terms of the assets at retirement or the amount of consumption or spending replacement some someone could expect.

Kathryn Farrell:  And I think intuitively, again, you could expect that over a lifetime when we model this out, you can expect, in general, higher levels of assets that retirement or consumption replacement through retirement from that higher level of equity and that glide path that's focused on that distribution base.

Kathryn Farrell: So, here, we can see that the distribution base glide path significantly outperforms in 76% of the scenarios that we tested. We see that the values for assets at retirement and consumption replacement through retirement were higher for the glide path that was optimized based on the distribution of inputs.

Kathryn Farrell:  And an extension of this is the relative improvement in spending replacement. And it actually grows over time using the distribution-based approach. So, we find that the difference in consumption replacement between the distributions and the average is base glide path growing from about 2.4% per year to 5.4% per year.

Kathryn Farrell: So, really, to think about this and give you an example, if you had a final ending salary of $100,000 per year, and you're trying to replace 80% of that, that would mean you're trying to get $80,000 per year. If you can get a 4% improvement to that salary replacement, that's an extra $3,200 each and every year of retirement.

Kathryn Farrell:  So, that's really meaningful in terms of outcome, certainly could be an extra vacation, but also money to repair a roof, for example, or your car during retirement. And so, that's what's really helpful when you think about, again, that unknown in terms of how much you need during retirement and what expenses could come up along the way. And we tend to see that that again, that difference tends to grow over time and can become really meaningful as you get further into retirement.

Kathryn Farrell: So, to summarize, the distributions-based glide path approach is able to provide for more of the collective needs across that population as a whole and improve the outcomes for that regulation overall.

Jenna Dagenhart: Well, thank you for sharing that data and there's examples. Looking at the example of incorporating a more realistic range of inputs to get a better outcome seems to imply that taking that a step further and looking at something like a custom target date or managed account might be needed.

Kathryn Farrell:  That's a great point. So, when you think about designing a glide path that's for that broad and diverse population and you think about the challenges of doing that and how you have to design a single bypass to meet the needs that you could solve to create an individual glide path for an individual that would completely get rid of the issue of heterogeneity overall, and you could get a good fit for that individual.

Kathryn Farrell:   But there are some challenges, particularly when you think about a custom target a portfolio or a managed account being used as a default. So, managed accounts in particular, they generally could have a better fit for an individual, but you need a lot of engagement from him. So, you need someone to share their preferences, define their preferences, give you inputs that you wouldn't be able to get otherwise.

Kathryn Farrell:  So, give you some insights into what their goals are for retirement if they want to, again, create that bigger pool of assets or if they want to respond to volatility more, also get engagement throughout their lifecycle, so you can respond as their salary changes, as their savings rate changes. Potentially outside assets are included as well. And then engagement is really difficult. It's really hard to get participants to provide those insights and provide that level of detail that could help create a more customized client.

Kathryn Farrell:  And then the tradeoff that we see in the industry today is that often a managed account will have an additional layer of fees. And without the engagement, if you're getting something that's generally more generic and in terms of the outcome, but you're paying more for it, it's definitely not going to be a successful setup for a participant. And then even on the custom side as well, when we look at what is asked in terms of creating a custom mandate for a plan, we typically hear in conversations that sponsors or their partners are working with to describe their population as being really unique.

Kathryn Farrell:  They generally unique industry. They have unique type of salary. They have a unique type of age cohort and their population. But what we tend to see when we drill down into the data that they have the same problem as everybody else. Generally, they're underfunded. And that happens throughout industries that happens throughout age cohorts. And so, that's something that I think when you again, look a little bit deeper in terms of the need for a custom mandate, the need is, again, something that we generally see and respond to within our framework overall.

Kathryn Farrell: Other ways to customize, including outside assets or specific asset classes, or having a view in terms of the implementation, that's where I think some different types of preferences come into play. But overall, we know that there are tradeoffs in terms of those as well.

Andrew Jacobs v...:  And maybe I can just jump in here really quick. I think custom target dates, in particular, have gotten quite a bit of attention over the last few years. And I think, to me, the way I would summarize, I agree 100% with Kathryn. I think it's if you think about it, if you summarize it, to me customer is about control and the need for control, particularly. Is it are you willing to do it, if there's a particular need you're trying to solve.

Andrew Jacobs v...:  So, to me that there's a couple areas of control, one control the glide path, and that's kind of what Kathryn was talking about. If a plan sponsor feels that their particular population is significantly different than when you see kind of in the wider population, then potentially there is a rationale for looking at the glide path design.

Andrew Jacobs v...:  The other piece is if you want control of portfolio construction, I think, sometimes here, it's about what other asset classes you want to include in your design, how much diversification do you want? And here are some of the questions are, do you have a preference for some of the nontraditional asset classes, things that aren't typically included in many of your off the shelf strategies.

Andrew Jacobs v...:    The other air control is just a manager selection and implementation. So, if you want to leverage due diligence, if you're already doing in the plan and incorporating that into your design, then potentially there's a benefit there as well.

Andrew Jacobs v...:  And then, maybe the last part of control is just around costs. So, I think this is one that's widely marketed. But to me, kind of the hard thing to get is benefit of cost. You need to be very large. If you want to leverage your scale for institutional pricing, that's really for the largest end of the market, really the only other way that you can manage your cost is just the amount of underlying strategy, passive strategies in your design.

Andrew Jacobs v...:    So, I think the barriers, ultimately, in this space is really scale. So, it's kind of that same point, again. I think it's just do the added cost you're going to need in a custom design. You're going to need to hire your own custodian. You're going to need to hire your own accountant. In addition to that, another barrier is complexity. So, a custom product, you're going to need to create custom communications. There's nowhere where participants can go out and look at a ticker or look at performance. You can strike your own nav, do your own performance. So, there's an additional layer of complexity.

Andrew Jacobs v...:    And all that comes with an added fiduciary burden. So, you've kind of broken something that's kind of packaged together, this kind of one size for all with many different layers that build into it. And now, you've broken it out into design, construction, manager selection, managing costs, et cetera. And so, this creates an additional fiduciary burden on the part of the plan sponsor or their advisor, so they're going to need to kind of take on this additional fiduciary responsibility that's typically included in some of the bundled off the shelf products.

Jenna Dagenhart:   Now, that's a good reminder of considering tradeoffs. Another area we often hear about is the importance of tradeoffs relative to using active versus passive management. Can you talk about the differences in those options?

Andrew Jacobs v...:  Sure. So, yeah, I think this is kind of our third tip for plan sponsors, which is really around the use of active or passive underlying building blocks. And I phrase that very particularly that way because there really is no such thing as a passive target date solution. There are many active decisions that need to do even in the kind of "passive" designs.

Andrew Jacobs v...:    You have a glide path, an active decision to make in terms of the glide path design, its shape, its level, the level of diversification, and what underlying components to include in the design. So, there's many, I would say, active decisions, regardless of if they're considered to be active or passive targeted products.

Andrew Jacobs v...:   So, when you think about that passive debate, it's important to remember, it's more than just about the cost. So, clearly, targeted solutions that use passive underlying implementation, there'll be a kind of a cost benefit, versus an active or a blend strategy. But I think there, you have to dig a bit deeper. You have to think about those tradeoffs that you just mentioned, Jenna. And it's ultimately about being aligned with what you're trying to achieve.

Andrew Jacobs v...: So, if you think about capital markets broadly, they're clearly areas in the capital markets that aren't particularly efficient or even easy to access from a passive underlying implementation. I think, high yield is a great example of this. Full replication of the benchmark is just as impossible. You can't source all of the individual issues in a benchmark. And so, that makes passive relatively difficult as well as if you think about benchmark instruction. Those benchmarks skewed towards the most indebted companies. So, it's kind of where the most amount of debt those creates the largest weight on the benchmark.

Andrew Jacobs v...:  And so, clearly here, in our view, having an active implementation makes a lot of sense because you can build something in a way that you think we'll achieve better outcomes over the long term. And you really can access, kind of the fundamental research can kind of pay dividends over the longer term.

Andrew Jacobs v...:  The second piece is around the opportunity for adding value or the flip side of that, mitigating downside risk in the portfolio. So, clearly, with an active implementation, there's optionality. And I think, in my mind, particularly in the current environment, if you talk to practitioners in the industry about their forward-looking expectations for both stocks and bonds, they're significantly lower than what we've seen historically.

Andrew Jacobs v...:  And so, what that means for savers is that ultimately, the expectations for the future are much lower than where they were historically. And that means outcome seems balances, the expectations for balances will be lower as well. And so, if you can find consistent areas where you can consistently add value, even in small amounts of half a percent over time, that can have a meaningful impact in terms of the outcomes for your participant plan, meaning their balances at retirement.

Andrew Jacobs v...:  And I think, particularly for targeted products, I think this is really an ideal place for these kinds of active implementation, just given the time horizon. So, again, as Kathryn mentioned before, these are ones where we see people staying the course. And so, you're able to compound those value add from active management over time. And so, you really have this effective time that can work for you.

Andrew Jacobs v...:   And maybe the last piece, I'll mention, I think this is probably a nascent area in the industry, but one that's again, gathering a bit more interest recently, is just around active management. It can allow you for a more streamlined integration of ESG, so environmental, social and governance factors. This is because individual active manager can kind of weight the importance of each. So, every company may have, each one of these pillars will have a different impact on each company given their situation.

Andrew Jacobs v...:    And so, from an active management perspective, you can actually skew those weights where it matters in terms of those pillars. So, it's, again, kind of an early days in the industry, but one area where if that's important to a particular plan sponsor, we think active management makes a lot sense.

Andrew Jacobs v...:      I would say on the flip side, there's clearly several considerations that would argue for using passive. So, clearly, you get a lower fee profile. So, that provides this kind of attractive value proposition, particularly if you think about areas of the market that are really efficient. And so, you can get cost for value is relatively high in some areas of the market. You can kind of get that market exposure very cheaply.

Andrew Jacobs v...:  The flip side to kind of the opportunity for value add is potentially you'll reduce the risk of having a meaningful underperformance versus a benchmark with a path of implementation, and also reduce the overall tracking error of your portfolio.

Jenna Dagenhart: There seems to be a sense in the market that a plan sponsor could get greater fiduciary protection by using a passively managed target date. Is that a consideration as well?

Andrew Jacobs v...:   Yeah, so I think there's a lot of concerns in the market on the part of plan fiduciaries, particularly when it comes to costs within the by contribution plan. Many plan sponsors that we talk to quite frankly, I'm feeling overwhelmed with the thought of kind of litigation or some of the regulatory burdens that come with selecting investments for planning participants. And so, as I think about the decision for selecting the right investment for plan participants, I think there's often the question that you see from plan sponsors are, are these added costs for active management even worth it?

Andrew Jacobs v...:  And I think, unfortunately, I think there's quite a big misperception in the industry that if you go passive, you're fine, you're safe. I don't think that's true. Regulators really haven't given kind of a free pass for passive options from regulatory burden or for a litigation perspective. We've seen plan sponsors and passive target dates get sued for both fees or underperformance.

Andrew Jacobs v...:  And so, I think it kind of comes back to, at its core, thoroughly evaluating kind of those features and benefits, the value for cost of your investment, and importantly, documenting your decision-making process. I think that's of the utmost importance.

Andrew Jacobs v...:  And so, particularly, when you think about kind of the features and benefits, there are many things that through our everyday life, you wouldn't argue to shop on price alone. Think about the example of when you're shopping for a car, so often it's kind of what are you looking for, what are the things that matter to you? I had someone that I worked for many years ago, and we couldn't be any different. He shopped on cars based on the number of cupholders in the car. That was really important to him. He would have hated my car because the cupholders were designed, they were terrible design of cupholders.

Andrew Jacobs v...:   But we were looking for very different things. If you have a family, you have kids, a minivan is a really great for moving kids around. It has this extra storage. You can go on your trip. But it's not super efficient. It's not the same market as somebody who's looking for a large electric vehicle or it's not great for tight spaces if you live in a city. So, I would say similarly, when you're looking at target date products, the drivers of outcomes, things like glide path design, diversification, a lot of these things can vary very significantly across the providers in the industry, including the "passive" providers.

Andrew Jacobs v...:  And so, when it comes down to it, I think in order to satisfy your ERISA prudent standards, I think a fiduciary really needs to make an informed decision. That means thinking about what's my consistent decision-making process and really to start to focus on value for cost and not just cost alone.

Andrew Jacobs v...:  So, I think the challenge is that, clearly, and there's a lot of academic research on this, your average active manager may not be worth the fee. And so, I think there's definitely effort involved in finding quality active management. But we think it's possible with kind of that additional effort that due diligence. And over the long term, if you can source it, it can have a pretty meaningful impact on your participant outcomes, meaning their balances at and in retirement.

Andrew Jacobs v...:  So, the way I frame it is, I think there's value to both. I don't think there's a single solution, an ultimate solution. The benefits are active. The benefits are passive. And it really comes down to your process and how you weight those tradeoffs and how you prioritize the benefits of each one of these different implementations. And clearly, low fee sounds good, who wouldn't ... We all do.

Andrew Jacobs v...: You kind of look at who you shop on, price, or it's an important factor. But I think you wouldn't want that to come at the expense of things like glide path suitability or diversification. So, I think you need to be very attuned to those tradeoffs.

Andrew Jacobs v...: So, what we're seeing actually in the market, which is kind of interesting is we're actually starting to see a move towards blend design. So, it's kind of a term that encompasses products that use both active and passive. So, clearly, there's a recognition that both have a benefit. And so, you're seeing kind of this blend approach starting to grow in the marketplace. But then again, this creates another complexity. So, it's one more thing to think about when you look at your selection of providers.

Andrew Jacobs v...:  And I think it's important to remember here, not all blends are created equal. So, managers have different approaches in terms of how they implement blend, where they use passive. And so, I think it's really important to understand those differences, just like when you look at a traditional active manager or passive manager, understanding that glide path design philosophy, understanding diversification, and understand, ultimately, how they're using their active expressions within each one of these kind of varying products.

Jenna Dagenhart:  With that background, let's tie this all together and see how it works in practice. We have two case studies to review. Let's see how these discussions came together.

Kathryn Farrell:   Absolutely. I'll take the first one and talk through an example where we spent a lot of time with the plan sponsor that went through this process that use these types of tips to make a selection of a targeted strategy for their plan. It was really fun. They spent, again, a lot of time digging into what are the tradeoffs. And they also spend a lot of time thinking about what are their preferences or what are their objectives. And that was really informative as they went through this journey to decide what do they want to be doing for their participants and then how can they implement that.

Kathryn Farrell:  So, we spent a lot of time with them talking about target date design. They interviewed active managers. They interviewed passive managers. And as Andrew mentioned, those are oversimplifications. But in terms of the implementation, they were looking at the range in terms of the industry. They looked at different providers in terms of the level of equity within their glide path. So, to say, well, what's the tradeoff of having a higher equity approach versus a lower equity approach?

Kathryn Farrell:  They figured out really as a committee that they were more paternalistic that they wanted to think about how can they do well by their employees, which I think was a really wonderful approach for them to take as fiduciaries for their plan. They worked with a consultant. But really the committee was driving this process to say, we need to decide what our philosophy is and what the objective is.

Kathryn Farrell: And we did spend time looking at demographics with them as well. They were a large healthcare organization that was bringing together a number of plans. And so, they had a lot of different cohorts to go through. But again, when we look at all of the data, we see that when you look at a broad population like that, again, the needs are typically that there's generally lower savings and there need more growth from their portfolio.

Kathryn Farrell: And when the committee looked at the tradeoffs in terms of taking that approach of saying, well, we want to learn and create a design, we want to create a portfolio that's going to meet the needs of all of those different cohorts, that was, I think, a good turning point for them to continue to narrow down their search. So, setting their objectives and preferences, and then looking at demographics to see how those could be aligned was a good step for them.

Kathryn Farrell:   The committee seemed very fee sensitive, very cost conscious as we were going through this process. And we had a lot of discussions about different types of solutions and what the fee profile would look like. But then as they looked at the considerations that Andrew mentioned, so things like diversification that you can really only get utilizing active underlying strategies, and the impact to outcomes, especially thinking about lower expectations for returns going forward, if you can get higher net of feed performance from active implementation, that can really meaningfully move the needle in terms of outcomes for participants.

Kathryn Farrell: So, they did end up thinking about the tradeoffs of an active implementation versus a passive implementation and the opportunity to add extra returns, net of fees ended up being one of the deciding factors for them to move forward with an active implementation.

Kathryn Farrell: So, it was again, I think, a really thorough exercise with the plan sponsor. And they dedicated the resources, they dedicated the time to going through these steps and documenting along the way, all of the decisions that they were making, and all of the tradeoffs inherent in this process. But that really gave them a lot of comfort I think with the outcome. So, again, it's relatively a luxury. A lot of plan sponsors are doing day jobs that aren't just looking at investments day in and day out. And so, setting aside the time to make these decisions is sometimes hard.

Kathryn Farrell: But it is a great outcome in terms of finding a solution that is going to be a good option for participants in the plan, especially when it's a qualified default investment alternative or QDIA. And you know that means that participants who are being enrolled in the solution would move into this investment. You got to spend the time on it and you got to feel good about the decision and the process that you go through to make the correct one for that plan.

Kathryn Farrell:  So, again, this was one plan that we worked with, where they ended up going with a higher equity approach with an active implementation because they were, again, really focused on the outcomes across that, that broad population that they were bringing together as they combined plans.

Andrew Jacobs v...:  So, our second example that we have, so we worked at length with a corporate plan, and this was a plan that had a long history of acquisitions. And so, where they were sitting, they were looking at a broad array of kind of segregated plans, different managers in each one of the plans, different implementation, active and some passive and others. And really, what they want to do is they wanted to harmonize choices across all of their participants.

Andrew Jacobs v...:  And so, we started our conversations with them. They had a clear preference for maintaining assets in the plan. They really wanted to kind of be a part of that journey, that retirement journey for their participants and keep them in the plan, even past retirement. And one of the things that was relatively unique with this plan is they had a very high rollover balances. And so, it really kind of the plan had an express with the ... As part of the design, they really want to make sure that we had kind of that full financial picture for all of their employees.

Andrew Jacobs v...:   And so, when we started to look into the data of this plan, what you saw is that the plan was very well funded. We had relatively high savings rate, a really generous company kind of contribution, and even had a subpopulation that had a defined benefit for a small cohort of the population. And so, this means that empirically, they didn't necessarily need the extra growth in terms of their glide path. And I think it was really important is that they were comfortable with a lower equity design and with those expectations for a lower expected return and a lower expected volatility.

Andrew Jacobs v...: And I think this is one of the things that's really important. I think, particularly within the target date space, it's difficult to compare different designs. I think it's really about those expectations. So, here, the fact that they want a lower equity design wasn't driven by a lower risk tolerance or risk objective on the part of the plan sponsor, but more a function of the kind of the savings behavior that you could see in the plan.

Andrew Jacobs v...:   So, the participants didn't need the extra volatility, didn't need the extra growth. And so, they were comfortable moving to a lower equity design. And they were also the kind of reset those expectations. So, they would compare themselves to other low equity providers and not just kind of the average of the targeted space overall.

Andrew Jacobs v...:  On the implementation side, I think this was a really interesting conversation. This was a client that had a very sophisticated investment team. They had historically managed the defined benefit assets internally. And they'd always managed them using a blend approach. They believed in the benefits of active and passive. And historically, within their own investment team, they'd been using passive in areas of the market where they felt they can get very good value for costs. So, primarily in kind of large cap equities.

Andrew Jacobs v...: But importantly, they weren't fully enamored with the idea of going passive overall. And they were especially concerned within fixed income, an area where they were active within the defined benefit plan. And they were concerned from kind of the longer term perspective that fixed income benchmarks, ultimately, are difficult to replicate. But also, I think, really importantly, they were concerned about kind of the current market environment, the current economic cycle, and ultimately, what you get when you buy a passive, US aggregate based product. So, ultimately, what you're getting is a long duration with a low yield.

Andrew Jacobs v...:  And so, they had this express preference for active management within the design. And so, ultimately, they ended up going with a blend approach. I think this satisfied kind of their goals in terms of a portfolio construction. And I think the key decision for them is, and typically, as you see a defined contribution price, what this meant is for some other population that was in a passive product, there would be a slight fee increase.

Andrew Jacobs v...:  But ultimately, it was kind of that assessment of value for costs. And they felt very comfortable that that additional value was there through this active implementation, or this kind of move towards active within those that blend in implementation.

Jenna Dagenhart: Finally, it's clear you're thinking of retirement planning as the long game and to help plan sponsors make decisions in the best interest of their participants for success in retirement. Can you recap those three tips again?

Kathryn Farrell: We are. And to do the work, it's helpful for sponsors to have a foundation because this is a long game, as you mentioned, and it does take some effort. There's a lot to consider. There's a lot of challenges participants are facing, but again, there's bright spots, and there's definitely opportunities for plan sponsors and their partners to develop a framework that can help the foundation as they go through this process and they navigate selecting a target date and overseeing their target date offering.

Kathryn Farrell: And so, again, we would summarize our discussion really around three key areas, three suggestions, three tips for plan sponsors to walk away with as they're going through this evaluation process. And the first is to think about objectives, to think about what your goals are as a committee, what your objective is for offering a retirement plan. What do you really want to be doing in terms of offering your participants outcomes? What does success look like in terms of an outcome? Think about that goal or objective.

Kathryn Farrell: And then think about demographics. So, then think about what do your participant, your plan characteristics look like? And does that align in terms of following that demographic, excuse me, following that objective and can you think about solutions that will go well with both of those components, that objective component, and then the plan characteristic component.

Kathryn Farrell: The second tip is to think beyond averages. Don't take the data on plan characteristics and simplify it into a single number or a single value, because that's not real life. We want to select inputs that are going to be realistic, that are going to give us comfort in terms of the modeling, and the experience of all of the participants going through this plan. So, really think carefully about the needs of that entire population and don't sacrifice the needs and outcomes for participants for simplicity's sake.

Kathryn Farrell: And then third, finally, think about implementation really critically. There are tradeoffs, as Andrew mentioned, in terms of utilizing passive management under the hood, versus active management. And investing in a target date thinking about retirement, that's a long time horizon. You don't want to sacrifice tomorrow for today in thinking about what are the opportunities that you might be leaving on the table by only utilizing one type of investment.

Kathryn Farrell:  Active management can give you, again, the level of diversification that's really important in terms of thinking about these portfolios being used for multiple market cycles with multiple generations of workers and the extra return that might be possible, so utilizing active management over the long term. So, again, hopefully those three ideas can help set the stage for plan sponsors as they're going through this process.

Jenna Dagenhart:  And before I let you both go, are there any final thoughts that you'd like to leave with our viewers?

Andrew Jacobs v...:  So, we'd say I think this can come across ... It can be a daunting question if you think about selecting your default investment for your plan participants. And I think this is where kind of process comes in, trusting the process, having a systematic, documenting the process, what are your priorities, again, kind of that hierarchy of needs. It's difficult to find something that will meet all of the needs equally. So, it's about prioritization and creating a hierarchy of need and making sure that you're selecting something that scores well in terms of your highest priorities.

Kathryn Farrell: I say, work with partners that can help you with this process as well. So, don't hesitate to reach out to your contacts to make sure that you're getting the resources from anyone available that can help you navigate this process and make the most informed decision possible.

Jenna Dagenhart: Well, Andrew, Kathryn, thank you both so much for joining us today.

Kathryn Farrell: Thank you.

Andrew Jacobs v...:  Thank you.

Jenna Dagenhart: And thank you to everyone out there watching this exclusive T. Rowe Price Masterclass. Once again, I was joined by Kathryn Farrell, Portfolio Specialist, Multi-Asset Division, and Andrew Jacobs van Merlen, Portfolio Manager, Target Date Strategies. I'm Jenna Dagenhart with Asset TV.


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