MASTERCLASS: Target Date Funds

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  • 01 hr 00 mins 26 secs
Four experts discuss how inflation impacts investors as they’re preparing for retirement, how target date funds manage through changing market dynamics, and why risk management is especially important in the current environment.  They also explain the tradeoffs of different target date implementations, the role of ESG and alternatives, and other important considerations when evaluating target date funds. 
  • Sarah O'Toole, CFA®, Institutional Portfolio Manager - Fidelity Investments
  • Christopher Sharpe, CFA®, Chief Investment Officer, Multi-Asset Portfolios - Natixis Investment Managers Solutions
  • Jeremy Stempien, Portfolio Manager of the Prudential Day One Funds - PGIM
  • Kim DeDominicis, Multi-Asset Portfolio Manager - T. Rowe Price


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Transcript MASTERCLASS Target Date Funds

Jenna Dagenhart: Hello and welcome to this Asset TV Target Date Funds Masterclass. We'll discuss how inflation impacts people preparing for retirement, how target date funds manage through changing markets, and why risk management is especially important in the current environment. We'll also look at the growing role of ESG and alternative investments, as well as the trade offs of different approaches.

                                    Joining us now we have Kim DeDominicis, multi-asset portfolio manager at T Rowe Price. Sarah O'Toole, institutional portfolio manager at Fidelity Investments. Chris Sharpe, Chief Investment Officer, Multi-Asset Portfolios at Natixis, Investment Manager Solutions, and Jeremy Stempien, portfolio manager of the Prudential Day One Funds at PGIM.

                                    Well everyone, thank you so much for being with us today. Target date funds have been around now for more than 25 years. Chris, how have they evolved over that time?

Chris Sharpe: Sure. I guess you're giving me, I'm the oldest of the group, so I get to wax on about the good old days of target date funds. But I do have a long history, that 25 years is kind of right where I started.

                                    So I guess some things have evolved and some things haven't. At the very heart of it, the intent is the same, to provide a successful retirement for our shareholders. And by success, with social security savings and match investment performance, a good level of retirement income in retirement. And the underlying objective though, is to simplify the investment process for participants. And that remains the underlying structure of target date funds. And that will be, and continue to be the thing.

                                    The basic structure is state-stable. Typically, we have five-year investment buckets for participants to invest in. It's a single investment fund, which makes it easier.

                                    The glide paths are a little changed over the past many, many years. And that speaks to the difficult retirement challenge of meeting that successful retirement. It's difficult and it's not going to allow us to play too much with those glide paths. So things haven't typically changed. We start generally in the nineties, and we end up somewhere in the twenties in terms of an equity allocation.

                                    Other things that have evolved over the period of time, there's been two versus through debates, and I think that's largely been resolved. Again, because of the challenge of saving for retirement. That we, most people don't have sufficient income or sufficient savings to provide a really generous income. So they need to continue to invest relatively aggressively up to and through retirement.

                                    If we go back to the aughts or the two thousands, one thing that was quickly adopted and continues to be sort the bedrock of target date funds is their use as a QDIA, a qualified investment alternative option, and making that sort of the default option for investors.

                                    And that's, I think, one of the most important things of target date funds. Is that the comfort there, in terms of choosing an investment option, the appropriate investment option, and making it the default, that continues to be the same.

                                    Other things we've seen change is investment vehicles. It started off in the world of mutual funds, separately managed accounts and CITs have come across. But again, varying investment structures sort of moving through and providing our investment levers. So that hasn't changed too much. There's been some adoption. We ourselves are a multi-manager approach. We're seeing more talk of that, but predominantly it tends to be a proprietary product type of structure.

                                    Other things that are continuing, but I think much flying cars, we're still waiting for that to happen. And it's happened on the margin, but the income element and how that plays a role in target dates, and whether it's sort of a bundled guaranteed option or distribution mechanism. There's been attempts after long thinking about how best to approach that. But still kind of early days, quite frankly. After several years of talking about it.

                                    But at the heart of it, I think, like I said, many things have changed many things have changed, many things haven't. but the benefits continue to be strong for target date funds. They're helping people take age-appropriate risk across a breadth of asset classes. We're managing that shift in asset allocation along the glide paths for our participants. And with the underlying rebalancing staying on course, and that underlying investment management oversight that all of us do in terms of the underlying investment strategies.

                                    And it's really sort the hallmark of these types of strategies. But at the end of the day, one that I is a pervasive issue, long in these 25 years, has been that we need people to save more. And that's the biggest challenge, and that's why we haven't seen changes in the glide path. Because there seems to be continued sort of under investment in the space.

                                    And we need people to contribute more, auto escalation, matches, everything's getting better. But in terms of a PC target date plan or strategy being the principle investment vehicle for saving over for retirement, that continues to be the greatest challenge in the space.

Jenna Dagenhart: Turning to you, Kim. T Rowe Price launched its first publicly available target date solution 20 years ago. How do you feel the industry has changed from 20 years ago to today, and what's the same and what's different?

Kim DeDominicis: Well, I would say when T Rowe launched our target date series just over 20 years ago, we were really kind of in the early stages of target dates. And certainly, we've seen a lot of evolution over that time. And I think that that's certainly still true today.

                                    I would say our desire to help clients really achieve their retirement security has remained over that 20 year time period, and has really grown over time. We've learned quite a bit in the 20 years that we've been managing target date portfolios. We know more about participant behavior and how people utilize target date strategies. We're really encouraged to see that participants by and large, those that are invested in target date strategies, tend to stay the course and they're actually using the portfolios quite well.

                                    We've seen an increase in life expectancy, and I think that that trend has certainly made us feel comfortable that the need for retirement income is even greater. Given that people are going to live longer and need their retirement asset base to last a longer period of time.

                                    And I would say that even though we've seen quite a significant shift and an evolution over that 20 year time period within the target date landscape, one thing that really hasn't changed is that we've really stayed very focused on the end client. And we've really maintained that focus over time, and we've really made sure that we've maintained the courage to really do what is best for our end client in the target date space.

Jenna Dagenhart: And after more than a decade of strong capital markets returns, lower than average volatility and low inflation, inflation has spiked and market turmoil has returned.

                                    Jeremy, given the market challenges and volatility that even target date funds are experiencing today, how do you think about risk for target date investors, particularly for those moving toward retirement and in retirement?

Jeremy Stempien: Yeah, I think it's a really interesting question now more than ever. And to put that into context, if we look backwards, target date funds have, Kim just gave context, they've been running it for 20 years. Which is kind of crazy when you think about that in some sense. They were very early, right? Target date funds really took off after the Pension Protection Act, probably call it 15, 17 years ago. That's when they really took off in the DC space.

                                    And what we've seen, more or less since then, is we've seen the market sort of gradually, continually work its way upwards. It's been sort of a very great environment for DC investors. Is for the most part we've seen markets sort of head upwards. And obviously, the global financial crisis maybe is the one exception. But when we look back then, target date funds were about, I think, roughly $160 billion in total assets and counted for about 8% of the DC assets.

                                    Whereas we look today, target date assets are over 2 trillion in AUM, and they comprise about 65% of DC assets. So they're such a bigger piece of the pie within the DC space today more than ever.

                                    And we look back and think about this environment where markets have been performing very, very well. We've seen a lot of target date funds really kind of take advantage of that. And what we've seen over time is in order to, given the competitive space that it is, many target date funds kind of leaned into risk a little in an effort to achieve better returns. And it worked out very, very well for the target date managers, target date funds, and the investors in them.

                                    And so we've looked today. And what some research we've done, we've looked and said kind of the four largest target date players that comprise almost 80% or so of the target date space. They, on average, when you kind of put them together for people between the ages of around 50 or 65 or a time horizon of about 15 years, those target date series collectively on average are nearly 10% more aggressive than the category average.

                                    And it's not really a surprise. They've done a great job of performance attaining assets by doing that. But I think the concern there is that plan sponsors flocked to the biggest players. There's safety numbers for plans, it's worked out well. But we've seen this environment over the last three years where the market's flipped.

                                    And Jenna, you mentioned some of these things, right? We've seen volatility come to light, a lot of concerns in the marketplace. And as a result of that I think there's people retiring now, who just retired or are near retirement, who have seen of their forecasted outcomes deteriorated substantially.

                                    So I think that there's probably going to be a realization by plan sponsors in the coming years of the impact that this environment's had on outcomes for individuals. I think we'll see a greater focus on risk for participants, particularly those, as you mentioned, maybe approaching retirement, getting close to retirement.

                                    Those series, I think, that put a little more emphasis on capital preservation, on looking at the [inaudible 00:11:05] and ensuring that not just post-retirement, but transitioning towards retirement, are really thinking about protecting people's wealth. Are probably poised to get a little more attention and garner some more focus by the DC industry going forward.

Jenna Dagenhart: Really honing in on inflation here. We've seen so many headlines about inflation, and I'm sure we've all felt the impact on our wallets as well.

                                    Kim, how does inflation impact investors as they're preparing for retirement? And how can target date solutions help mitigate the impacts of inflation?

Kim DeDominicis: Well, planning for the impact of inflation and how it can really impact an individual's purchasing power over multiple decades is really important. We recognize that inflation, even at low levels, can really have a meaningful impact on a retiree's ability to meet their spending needs, particularly in retirement.

                                    There are a number of ways that target date strategies can be built to really help to mitigate some of the impact from higher inflation. So for instance, having adequate equity exposure can certainly help mitigate inflation risk. Incorporating a high-level diversification specifically to asset classes that are going to be more inflation-sensitive can also be quite beneficial.

                                    So for instance, short duration tips, they can really be a great direct inflation hedge, especially for those who are nearing retirement. And I would say that one thing that we at T Rowe did quite early is, we recognized the need for making sure the overall portfolio design was one that incorporated some of these inflation-sensitive asset classes that would really help to have our end clients be more prepared. Thinking about inflation and how that might impact their overall portfolios.

                                    I would say another way that is beneficial in kind of responding probably more in a shorter timeframe, kind of a shorter-term outlook to inflation, is to have the ability to tactically shift your overall portfolio allocations. So for instance, when inflation is elevated, you can lean into or out of specific asset classes or sectors that are going to be reacting to inflation, again in that shorter timeframe as opposed to that longer time period.

Jenna Dagenhart: Sarah, how does Fidelity's target date strategy help participants combat the effects of inflation on their retirement portfolio?

Sarah O'Toole: Yeah, that's a great question, Jenna. And one we're hearing a lot in the market today, given what we've seen in terms of the inflation over the past 12 to 18 months.

                                    And I think, just taking a step back and thinking about all the risks that a target date fund manager is managing on behalf of participants in the strategies, is that every investment decision that we're making involves a trade off.

                                    So inflation risk is one of the risks we're balancing alongside market risk, deflation risk, and longevity risk, which we know is one of the largest concerns of the clients in the strategies.

                                    And when I think about inflationary environments, we really do spend a lot of time considering that type of market environment when we build the strategic allocation of the portfolios and the glide path. And these periods of inflationary stress can be uncomfortable, especially for a retiree who may not be able to access different sources or additional sources of income in their retirement.

                                    So the good news is, these periods tend not to be persistent. But we may move into them in a way that feels abrupt and unpredictable. And so what we've been focused on is allocating to assets that improve resiliency to these types of environments. So inflation-protected bonds and real assets, for example, are areas that we have the flexibility to add to if we want to be more inflationary-protected for the older investors and strategies.

Jenna Dagenhart: And we're still at the beginning of this panel discussion, but I've already heard the word risk being thrown around quite a bit. So Chris, what are the benefits of risk management, and why is it especially important in the current environment?

Chris Sharpe: Sure. I think Sarah, just building off of what Sarah said, yeah, there are a lot of different elements of risk. The structural and the by design. And I think we alluded to in the glide path in the sense of this, the nature of this product and strategy is exposure to risk at the age-appropriate level.

                                    So it's equity risk that we're taking along the way, and that's crucial. And we always view it as sort of a equity, non-equity split in terms of the glide path. And managing that age-appropriate...

Chris Sharpe: Equity split in terms of the glide path and managing that age appropriate risk. So, there's that risk that we're taking within the strategy to deal with some of those other long term risks that Sarah mentioned, like longevity risk. Those are sort of more permanent and know. They won't change with the markets. They're just the challenge that we have. So, it really breaks down the two elements. There's that structural risk that we're taking in terms of structuring the glide path and our funding risk and our longevity risk that are all dealt with at the design level. Then, there's the other element that I think is more pertinent to the inflation conversation and we're seeing. I switch from that side of asset liability risk to an asset only risk. That's where I think it's key to really understand what you own and where it fits into the process.

                                     [inaudible 00:16:51] We view risk management as very much at the front end of the process in terms of the architecture and how we design things. That's understanding things at the total portfolio level, at the asset class level, and at the underlying manager level, and viewing an X anterior look forward risk perspective. What do we have for structural risks? And, what are we seeing with the change in the markets? We balance the view between our execution levers, our strategies, our underlying investment managers with the aggregated holdings that we have. It's important to have a multifactor, multi-asset class system to quantitatively understand what exposures that you do have and mitigate the risks that you don't want and make sure that you're designing a portfolio that has the risks that you do want. For instance, in our portfolios that are active or hybrid, we want to make sure that we have a security selection driven portfolio.

                                    As we line up, for instance in our domestic equity strategy, look at our underlying managers. We know what their investment processes are, whether they're quantitative or fundamental. But, we want to see what their individual factor and exposures and tracking error and active shares are. Then, we want to see them on an aggregated basis, such that we want to see what may percolate up with some phenomenon that we're seeing of late that we haven't seen in the past 15, 20 years, rising rates, inflation that we're talking about, some real value rotation, the effect of a commodity spike, and those things.

                                    You can see that quantitatively play out in a risk management system. Understanding what inflation or rising rates means to your growth manager, your value manager, your small cap manager, even though that's not part of their mandate, understanding how that aggregates at a holdings level for the shareholder is really crucial to understanding what's going to happen. We can predict what our performance will be on any given day, because we know the type of exposures that we have. We're trying to make it as evergreen as possible in terms of that long data horizon we have.

Jenna Dagenhart: Now, given that most target date fund investors are defaulted into target date funds, we hear a lot about target date fund participant inertia, that target date fund investors don't react to market volatility. Do you think that's the case, Jeremy? Have target date fund investors been sitting tight amid the current equity market selloff?

Jeremy Stempien: Yeah, I think right now, over the last few years, I should say it's really a fascinating period to look at target date participant behavior. One of the greatest features of target date funds is that this term that we use often is they're very sticky investments, meaning to the point, people, target date investors, tend to be, generally speaking, passive investors. They don't come in and manage their portfolios. They tend to set it and forget it, is a term that the industry used for a long time. I think that's one of the greatest features of target date funds is that you don't get investors coming in and trying to market time. I think data has shown clearly that when people try to do it themselves and manage their portfolios actively, they tend to come up with much worse outcomes for themselves and do worse than they otherwise could have done.

                                    One of the greatest benefits is the fact that people historically have been very passive investors in target date funds and haven't taken action. But, I think we've seen that challenged a little bit during the pandemic. I mentioned a few minutes ago how we've seen, because the market environment has been good, managers lean into risk. So, looking at this period during the pandemic, we've seen volatility come up. We've seen some interesting data. We've looked at fund flows across the target date industry. What we saw is the 2020 category. That's designed for today, people who maybe just are recently retired. What we saw is it's probably mixed of some active, some passive, or some active, and some terminated participants. What we saw was at the beginning of the pandemic in the first quarter of 2020 when we saw the asset fee drop 34%, I think, in the period in February, for that quarter, we saw for the first time ever, massive outflows in target date funds in that 2020 category.

                                    So, they averaged, in the quarters leading up, about 1.6 billion in outflows. It more than quadrupled in the first quarter of 2020. We saw about 6.6 billion in outflows for that category, for again, people around the age of 65. They massively pulled out of the target date funds. Those are older individuals, so I think the experience was they wrote the market down. They pulled out of the target date fund. When you look at what happened after, we didn't see them come back. We actually saw the average flows after remain very, very depressed, about four billion per quarter in outflows in that category. So, those people conceivably missed the recovery of the market. Fast forward to the first quarter this year, volatility really hit the market again. We saw another record outflow in that category, about $6.8 billion come out, so these massive spikes and outflows when we see the biggest concern for volatility for the older individuals in target date funds.

                                    We also then said, "Okay, well, some of those people are retired. Let's look at the 2025 vintage for pre-retirees." We saw a very, very similar pattern. In the first quarter of 2020, it was one of the first times that that category actually went negative with flows. We saw net assets coming out of the category holistically and significantly. It went from an average of about $2 billion in inflows each quarter to about $4 billion in outflows in that first quarter, 2020. It's been negative every quarter since. Again, we're not seeing those investors come back in. We're selling at the worst possible time when the market's down, and they're sitting on the sidelines, missing the recovery. In the first quarter this year, that same category, another record outflow of about $5.5 billion in outflows for the quarter. We think those numbers are significant. We even looked at a couple of the categories beyond that, think 55 year olds, 50 year olds in a similar pattern.

                                    We really see these major spikes out, and we just don't see the recovery from a flow perspective, people coming back in. That's the most concerning part, is that for the first time ever, we're seeing people really take action. Target date investors are conceivably getting close to retirement. They're watching their portfolios fall 10, 15, 20, 25%. And, they're effectively saying, "This isn't for me. I'm getting out. I don't want this volatility." Then, they're missing that recovery and are probably getting the worst possible outcome as a result of that. So, that's a big picture at the category level, but I think it's such a significant period that we'll look back as a case study later and say, "There's a lot of learnings that are coming out of this three year pandemic period that we've been experiencing."

Jenna Dagenhart: Certainly unprecedented times, and your conversation about flows and potentially missing the market recovery reminds me of something, Jeremy, that one of our speakers said during the height of the pandemic. They said, "Don't touch your face and don't touch your 401(k)." So, I thought that was pretty clever. Now, Sarah, turning to you, how does Fidelity manage for changing market dynamics? And, how are you faring through this period of significant market decline?

Sarah O'Toole: Yeah, Janet, before we go there, I thought I would just make a couple comments on something that we look at with respect to investor behavior. At Fidelity, we are very focused on the behavior of the participants in the strategies, because one measure of success is did we keep investors in the fund through periods of market volatility? Our analysis that I'm referring to is mostly focused on the workplace savings plan. Our data is pointing there to investors continuing to stay the course. So, their behavior even in this recent period of volatility is consistent with prior periods. We look at it as a percentage of the target date participants who have all of their assets invested in a target date fund, the percentage that are making an exchange out of the fund. What we see is it's typically 0.2 or 0.3% are making an exchange out of their fund within their workplace savings plan.

                                    So, we are encouraged by those numbers, because as was stated earlier, obviously the resistance to market time is something that will benefit the investor. And, they benefit from a simple, yet powerful feature of a target date fund, such as rebalancing into the asset classes where appropriate. That's what we're seeing at Fidelity in terms of the investor behavior. In terms of the current market and how we're navigating it, I think it's really important to reinforce that our funds and target date funds broadly have a long term objective. Participants are likely to be in the strategies for decades from their early career into retirement and through retirement. These changes in market environments can feel uncomfortable, but we're focused on building a portfolio that can endure. During this period, we're very much focused on relying on our core investment principles, which are centered on diversification. We believe that the glide path and the strategic allocation can deliver on the goal of the target date investor, even considering what feels like a very uncomfortable period in the capital markets.

Jenna Dagenhart: And, Kim, the Fed's response to inflation has also been causing a lot of volatility in stocks and bonds this year. How can target date strategies help individuals navigate the ups and downs of markets like we're seeing today?

Kim DeDominicis: I guess the first comment I would make is one that certainly is consistent with some of the comments that Sarah just made in that given that target date strategies are really designed for an individual who is going to be saving for retirement for multiple decades and then likely in retirement for multiple decades, it's quite likely that during those multiple decade time period, that they're going to experience this type of market volatility that we've seen of late. Similar to how Sarah had shared her comments, I would say that T. Rowe also is very much focused on that long term time period. We think that's really appropriate. As a result, we built our portfolios to be durable over the long term. One way that enables us to incorporate the high level of durability is to make sure that we have exposure to a number of diversifiers underneath the hood.

                                    So, we have incorporated diversification not only on the equity side, but also on the fixed income side. I would say if you look back over the past decade or so, having exposure to a combination of S&P 500 and then the Barclays Egg would probably have done quite well. But, more recently, we're seeing that that's not doing as well. I would say likely going forward, that trend is likely to persist. So, we think it's really important to not only have diversification built into the portfolio design, but it's also important to be very mindful of interest rate sensitive asset classes and really to think about fixed income in the context of not all fixed income is the same underneath the hood. So, it's really important to make sure that you have diversification even within fixed income. Then, it's also important to make sure that you're incorporating those asset classes that are going to be uncorrelated.

                                    I know when we were talking about inflation, we talked about the ability to combat inflation through the addition of inflation sensitive asset classes, whether on the fixed income side, being short duration tips, or on the equity side, real assets, real asset equities being a great, great way to combat that. But, those also are uncorrelated asset classes and so add to the overall portfolio design in achieving that high level of diversification. Then, I think being able to incorporate investment decisions that are going to be more focused on active management, really enabling individuals to allow for security selection, we think that that's also likely to drive or add value, I should say, over time. So, certainly as we've managed our target date strategies for just over 20 years, we've done so through multiple up and downs in the market. We think it's really important though, to really make sure that you continue to maintain that long term view and really look past those shorter periods of heightened volatility.

Jenna Dagenhart: A target date fund series that implemented their glide paths with passive funds, AKA passive target date funds, have benefited tremendously from an intense industry focus on expenses. Do you think that the preference for passive will continue, Jeremy? Or, does active still have a place in target date funds?

Jeremy Stempien: Yeah, that active, passive debate is nothing new. I'm sure everybody certainly on this panel and everybody listening has heard the debate for many, many years, I think not just in target date funds, but across the DC space. I think there's two interesting takeaways that we think about now, given where we're at. One is just the overall fees in target date funds, right? There's this fear of litigation by plan sponsors and plan sponsor committees that often lead them to say passive is the point of least resistance. I can avoid litigation. I'm going to go passive. They make that decision based on cost, and this is, again, not a new concept. But, what we see most recently, and many of us saw this come across the news, but we saw our first glimpses at lawsuits against passive target date funds.

                                    I think there was about six of them in the past few months where plans got sued for going passive based on fees. Now, I'm not sitting here saying that means passive is bad, and those lawsuits have merit, right? Quite frankly, they're probably a bit frivolous and won't have legs. But, I think what it does do is it indicates and tells people that simply going passive to avoid litigation or to be safe isn't quite the reality. There really is no safe place or easy answer to being safe and avoid litigation. It highlights the fact that plan sponsors, advisors, consultants need to do their homework, look at the plan, and really come up with a decision on philosophically what makes sense for the plan and go in that direction, versus simply making it about something as simple as fees, right? So, that's one. Two is this is very similar.

Jeremy Stempien: Right? So, that's one.

                                    Two is, this is very similar to some of the comments Kim had just talked about, but fixed income and particularly passive investing in target big funds, right? So again, we're such a unique place now, right? We've got DC balances are bigger than ever, we've got the demographic showing that we've got these massive number of people already just recently retirement are moving to retirement. We got geopolitical concerns going on. We're coming out of a whole pandemic where companies are operating, different employees are working, they have before we got interest rates, hit historic lows and now there's skyrocketing up and possibly will come back down next year, again, inflation, volatility, I'm sure we can go on with all these things and given there's so much money in bonds today, bonds have gotten crushed and Kim [inaudible 00:32:50] this, year to date the ag's down over 15%, right? And that's the safe haven bonds over the three year sort of annual returns about negative eight and half percent for bonds, right? So bonds is such a critical sort of category for assets and target date funds. And we think active certainly has been poised, and historically has done better than possible, but particularly in these periods of volatility, that's what we really think additional diversification and active management can bring across different sectors. Being able to be a little more nimble with how they're positioning. That really, I think, benefits active fixed income investing, we believe that's the case in most environments, but particularly in an environment like we're in today, we think passive fixed income investing, this is really, really going to be challenge. And given the massive slide we've seen the passive fixed income, tar or passive target take funds, we think that's going to be again another thing that probably many plans and participants are experiencing now, and will for a number of years going forward. Looking back to see the impact of passive fixed income investing in the target date space.

Jenna Dagenhart: Chris, could you explain hybrid and differentiated investment processes?

Chris Sharpe: Sure. And it continues along with the theme of all three previous panelist comments just in the sense of, at the end of it, the evolution that we've seen is we're trying to come up with, we'll call it a net of fee, best risk adjusted return for our shareholders that we're trying to get. And so, whether that's the volatility of asset classes coming in, or whether it's an active asset decision at the risk of fees driving, and perhaps overwhelming a risk conversation in terms of what. And so I think continuing along that themes of trying to get that net of fee risk adjusted return performance that we look at, we talk sharp reach.

                                    But then also helping shareholders hold on to their allocations. Hybrid is just part of a natural evolution. When we look at how we started in the space, it was all active. An index came along and it was a sort of binary decision. We call it a debate, call it whatever, call it a philosophy. It was either active or passive and you know, take a step back and you realize, well that actually just doesn't make a lot of sense. Why don't we have something in between that gets to that net of fee, risk adjusted returns that are best serving our shareholders. And so, it's gotten to that sweet spot of a little bit of this, a little bit of that in terms of active passage in the portfolio. And I think that's perfectly the right balance and that's what we call hybrid strategy. And the drivers for that can be the potential inefficiencies in a certain spot, a certain asset location or sub asset, the class location or the lack of ability of a indexable space, if you will, a high yield for instance, it becomes a challenge. Or the other driver could be for portfolio construction and if you see that you have a structural underweight to something at the asset class level, you could put something in that's effectively a passive approach that will mitigate that risk.

                                    And so, that's sort of the hybrid side of things, but ultimately you need to measure performance relative to a benchmark. And with an all active strategy, you're taking the risk of performance up or down, relative to a representative benchmark. And with passive you're going down the path of that structural modest underperformance and without the variation. And so the hybrid allows you to potentially optimize if you will, that experience of going down the path, choosing to have active allocation to some extent, but perhaps if optimizing relatives to that performance relative to the benchmark.

                                    And then, continuing along that means sort of brings in the differentiated investment philosophy. Once you've chosen to go down that path and trying to form a benchmark, it's this balance and I think it was Kim that talked, the little balance is you want to diversify as much as possible and you don't want to have so many underlying investment vehicles that you've diversified, so far that basically become an index strategy. And so, it's important to look at those sort of risk management metrics that we've been talking about, like tracking your active share, factor, exposures and whatnot to get to the right structure. And one dimension of being able to do that is differentiated investment managers. If you've got different shops with different investment philosophies, different investment practices, you're going to have that natural diversification across different managers and that's going to smooth the ride. That's going to allow you to diversify, potentially not at the expense of tracking your active share. And so the more you can do that with very differentiated zigging and zagging going along, not to the point of nullifying but basically, having some positive relative to [inaudible 00:37:39].

Jenna Dagenhart: Building off of that theme. Sarah, what are some of the trade-offs of different target date implementations; active, blend, hybrid, index, you name it?

Sarah O'Toole: So we work with a lot of planned sponsors who are trying to evaluate what the best option is for their participants. Is it an index, blend or an active approach and for some plan sponsors it will come down to the fee? So they're looking for the lowest cost solution to a strategic allocation portfolio. We think there's much more to consider and if I had to boil it down into a couple comments, I think as you move from index, to blend, to active and target date, really expand the toolkit for a portfolio manager to navigate and manage uncertainty in the market, so you can get greater asset class exposure in the blend and the active strategies, you can get more flexibility to adjust those exposures through time to mitigate risks that you see in the markets.

                                    And so, what we try to encourage is for plan sponsors to really focus on the outcomes; their desired outcomes, what the portfolio manager has delivered in terms of outcomes, rather than just evaluate the fee in isolation. And at Fidelity we're seeing much stronger interest in blended solutions, some of the panels have called them, "Hybrid," but it's essentially that mix of active and passive because there are places in the capital markets that are more inefficient and have been proven areas for active managers to add value for individuals. And over time even small, incremental additional excess returns can be meaningful to our participants.

Jenna Dagenhart: Certainly very compelling. Now, circling back to something that you mentioned in your prior comment Jeremy, about how 2022 has highlighted the need for increased diversification, what do you think are some of the pros and cons for the inclusion of less liquid, alternative asset classes such as private equity, or private real estate into target date funds? And do you think that more target date fund managers will add these types of exposures to their series?

Jeremy Stempien: Yeah. I think that this is really relevant to a lot of the comments I just heard from Sarah and Chris. I like the way Chris actually stated his discussion around, it's a balance. I mean I look at our panel and we come from different target date here, and quite frankly when you look they're fairly different, which is great from a panel perspective on how they're managed. But it's all sort of balanced in a trade off. They'd be the first to say there is no right answer, it's all trade offs and you're trying to achieve different things and balancing these risks. And when it comes to sort the sub asset classes or the asset allocation, yeah, we think a lot about what I'll call sort of non-traditional asset classes, some we'll call them alternatives, others will say well those aren't alternatives when you look at things like pension space.

                                    But we think they can be really, really helpful and critical, particularly for older individuals where we see their role. So a little more target date managers, Adam probably as they become more accepted over time as DC space was a little slow. But it's continuing to evolve, which is great from our view. When I think about the portfolio management standpoint, managing our funds, we think for older individuals, very, very much we focus on volatility for these older people and the risk of the erosion of the purchasing power or inflation can have on the portfolios. So there, we think that some of these asset class can be very impactful, or something like tips can be great when we see inflation spike, it has. Commodities is for all the time commodities kind of took out the chain for a number of years, we've seen massive outperformance by commodities over the last three years.

                                    And then, real estate, right? REITs is a fairly common asset class in the DC space and target date funds. We also use private real estate, and private real estate is sort such an impactful asset class in our view to protecting on that downside and see volatility. Rates are great, but retail equity, they move up and down with the market and they can be very volatile. Private real estate can provide for a much smoother impact for a portfolio for participants, particularly close to retirement.

                                    And then maybe going forward we think there's a number of other asset classes that we continue to really like. We think about what the role is, when is the right time to include them in the target date series, if at all. And so some of those asset classes that we continue to work on, and think about are things like long-term bonds, infrastructure, defensive equity, private equity, even private debt, right? Private debt's one that's sort something we're looking at a lot at lately and looking at how it can impact, not just as a standalone asset class but when combined in a multi-asset class portfolio, I think about how can this achieve my funds, protect better on the downside, or really sort preserve that purchasing power for retirees and the funds over time. So, that's how we think about the roles of these asset classes.

                                    I am on the side of, I hope that these continue to gain traction sort of across the industry. I think they're very beneficial. You look at the pension space. Pension space has been doing it for years, right? That's sort of considered the, "Smart money," the institutional investor, they're very accepted here in the DC space. It's just a very different conversation in a different thought process. How plan sponsors and then participants think about the asset classes, whether it's on a core menu or in a target date series.

Sarah O'Toole: This is also a question we get from time to time from our clients and I think when I consider alternatives, it is a very broad asset class. So it's a category of strategies with very different attributes and objectives. But much research that's been done that alternative strategies can help improve returns, and mitigate risks relative to the traditional asset classes that really make up the majority of a target date fund. And so, we see some demand there. So it's something that we'll keep in mind. But again, we're really focused on picking asset classes that can provide a level of diversification for investors in addition to that long term return that they need to get to their retirement goals.

Jenna Dagenhart: And Chris, what are the potential opportunities that come with investment and customization?

Chris Sharpe: Sure. I would just add on in terms of the investment conversation, in terms of alternatives, and it's interesting with this interest rate reset and is it a reset goal? It certainly arise, there are two lenses I think you can look at it through in the sense of are bonds dead and probably not going to play a role in target dates like they did before? Not really in that camp, but I think I view it as a reset and now you can actually get something from bonds that's a return. But the alternatives is an interesting conversation because it is written or brought up by in terms of what's happened to the classic 60:40 portfolio in our model portfolios, not the target date portfolios, we do have allocations and some of our allocations are benchmarks are to have an allocated amount to alternatives and liquid alternatives both within our affiliate structure and then some of them are out of benchmark relative to that.

                                    And what we've seen over this past period, it really does play a role in terms of the portfolio construction, and getting that diversification, and getting something different than equities and different than follow. And so, I think it's going to be interesting to watch this space in terms of the acceptance of potential strategies in targeting. Because I totally agree it's more conservative; it's interesting to see how thoughts of evolve and when never let a good crisis go to waste and we'll see what happens in this space. It's really interesting.

                                    But it gets a little bit in terms of the customization question that you ask, we kind of view it as it's an opportunity. I've talked about risk management, and the role there in terms of filling gaps and whatnot, or having the opportunity to lending things off the shelf in terms of investment strategies that are perfectly appropriate or potentially adding things that sort of tweak to your mandate or tweak to the overall portfolio construction. And so, that's where I think the real balance or opportunity comes with customization. I'll give you two examples; so we have two strategies within our target date funds, both managed by AIA, one of our custom index groups, our custom indexing group. And the first strategy, we've had for a long time, but it's very unique and we have an ESG focused type of strategy but we do know that this is a DC investment that want to achieve that successful retirement. And so that particular strategy is call it smart, be call it passive, call it what, but it's definitely customized. And so, we're having an ESG focused portfolio that's constrained and optimized relative to a non ESG benchmark. And so for instance, we look at the SNP 500 value, non-ESG benchmark as the index to which this ESG portfolio is managed. And that's a very unique structure for us and we wouldn't be able to pull it off the shelf in the industry like that.

                                    The second example is, again, similar to the risk management conversation, but for the risk mitigation, one thing we saw recently in these markets is that we had a factor that was coming up in that multifactor type of environment and it was short term beta. And so we saw a little bit in our growth manager, we saw in one of our core managers and then our value manager. And it wasn't part of their investment process, but we were able to see that sort of percolate up with what's happened over the past 18 months. And so, we were again able to go back to AIA, build off of their existing investment strategies, but come up with a customized mandate that continued to be ESG focused in similar ways to the other strategies. But we actually put a parameter in there that constrained beta. So in aggregate, we were able to bring down the short term beta factor, one of many factors in a multifactor model to aid the overall portfolio. So this portfolio needs-

Chris Sharpe: To aid the overall portfolio. So this portfolio needs to stand in on its own, but then also for the good of the overall portfolio really helps the shareholder. And that's a customization exercise that you can't get with an off the shelf type strategy.

Jenna Dagenhart: Kim, why have target date solutions remained vital for investors over the decades, over the different market cycles as we've been discussing?

Kim DeDominicis: Well, I would say the reason I think that they have remained so vital for investors is, if you think about it, they're really offering that hands on approach. It has a dynamic process and it really helps the end client achieve their retirement goal over that long timeframe. So you essentially are thinking about a strategy that's going to be professionally managed all in one very convenient solution for those particular investors who want help determining what asset allocation is appropriate given the time horizon to or in retirement. And we know that that's something that's going to be a long time period that we've all mentioned over the course of this panel. I would say another piece that's important to note is that target dates have become an important aspect of the broader retirement savings in the context of millions of investors. And a lot of that is due to the fact that we've seen over time a shift away from employers offering a pension plan.

Jenna Dagenhart: Now, given everything that we've covered today, Sarah, how should investors be evaluating different target date funds and what are some of the important points to emphasize with plan sponsors?

Sarah O'Toole: Yeah, so plan sponsors due diligence of target date strategies is very thorough and I think of a target date solution as solving both an investment challenge and a savings challenge. So if I had to boil it down to three questions or points that I would want to answer if I was in the plan sponsor's shoes is on the investment side, how does the investment solution align with the goals of the plan and the participants? On the savings side are there education and communication resources available to help engage participants? And this is something we haven't talked too much about today, but we've heard from the clients we're working with that this is a very important part of the target date evaluation process, really helping people become involved in their path and their journey to retirement through platforms that can educate and inform. And then lastly, because these are very long term focused portfolios, thinking about the organization that will be the most valuable long term partner based on the unique or the dynamic attributes of the plan.

Jenna Dagenhart: As the baby boomers continue to transition into retirement, Jeremy, can you speak to the importance of retirement income and what PGM is doing on the retirement income front?

Jeremy Stempien: Yeah, retirement income is in every conversation that we're having now around DC, not just target date, but DC. And so a lot of our research right now is focused on retirement income. Retirement income is another one of those topics, not new in the DC space, but I think we're at some of an inflection point given the last three years where given the demographics and everything else, where we're starting to see our plan sponsors take real action or are interested in taking real action to help provide retirement income solutions. So I think when we look at the space, we think it's still very lacking across the DC space. A lot of products out there, whether it be a target date fund or even something else that's next to a target fund, they're rather simplistic in some respects, to look at essentially a net present value of what the portfolio needs to be at retirement and say, "That's our goal and you can spend X percent out of the portfolio going forward."

                                    But the reality is that that's not how participants practically act. Most don't just take their fixed payment withdrawing out of their DC plans. Markets go up, markets go down, people spend more when they're younger. People have medical issues, people have kids, everybody's a little bit different here. So we think from a retirement income perspective, thinking about the spending actually is a really critical way to help lead you to better solutions, better portfolios, and really decomposing participant spending. So the way that we think about participant spending, we break it into what we term participant needs spending and participant want spending. Need spending being those non-discretionary expenses that they have in retirement, paying their mortgage, paying for transportation, paying for groceries, those things that really they can't afford to not be able to pay in a given month or a given year.

                                    And then there's part of the spending that's more discretionary or their wants. I want to take a vacation every year. I want to go to Europe, I want to take a cruise, I want to join a country club, I want to golf. Well, if things go south, those are things that participants, they can probably cut back on. Maybe instead of going to Paris, they're going to go to Ohio for their summer vacation. So they have the ability to be flexible there.

                                    And when you consider the fact that there are certain expenses that are not flexible and others that are very flexible, it can lead you to different investment solutions and different portfolios for those participants to help ensure that they can pay for those needs. But we can be a little more flexible and strive with some growth with those wants. So I think research that we're doing there I think is going to help lead to better solutions for us that we can offer, whether that's alongside or within a target date series, whether it's next to, whether it's in something more personalized or customized akin to a managed account type solution. I think we're trying to look more broadly at how can we bring those to market and help people as they transition to and then are in the retirement years.

Jenna Dagenhart: And I'm glad that you mentioned ESG earlier, Chris, because we've also seen an increasing focus on environmental social governance issues as retirees look to align their investments with their values and as wealth gets transferred to younger generations. So Chris, what's your outlook for the role of ESG and retirement strategies?

Chris Sharpe: Sure, sure. Yeah, a lot of conversation of late in terms of ESG, certainly in the target date space, but just in general. And so over five years ago at Natixis, we launched with that focus in mind, of an ESG focus target date strategy, knowing that fully well that needed to be a robust investment vehicle and appropriate for qualified investment alternative and default option. And so that's the focus we've chosen. And I guess it brings in two different elements that I'd probably highlight. One is, or the two are a compensated investment factor. We believe it's an approach that has a particular investment strategy to it, as well as from the plan experience or the plan sponsor type of effect. And so from the investment factor perspective, we view it again as a compensated factor. And it's early days for ESG and it's certainly come along in the past 10 years in terms of metrics and the different providers and what does the E mean, what is the S mean and what does the G mean? And how should things be measured and should one be focused more than the other?

                                    So it's early days. And with that comes some challenges in terms of measuring it as a compensated factor. And I can see certain factor elements when I talk risk, I could see certain elements coming up as ESG or isolated as ESG. But again, it's still early days and understanding what it means, ratings, for instance, whether it's just analytics or MSCI or proprietary ratings, is it the rating itself that's important or is it the change in rating? And what we ultimately believe is more philosophical in the sense of those companies that focus on E, S and G as best practices or important pillars of their business strategy are going to be the ones that outperform. And those less, we'll use the pejorative term of rent seeking and whatnot. And the companies that focus in ESG are going to be the most progressive, probably more better run, probably the more profitable type of companies that will enrich our shareholders.

                                                            And so from an investment lens, that's why we've chosen to go down this path of an ESG focused type of strategy. The other aspect is in terms of what does that mean as an offering or default offering within a defined contribution plan. And here we've had over, I'm not going to get the number, I'll say over 200 plan sponsors invested with the Natixis sustainable future funds. A lot of those are qualified investment, diversified investment alternatives or default options because they've chosen to provide an investment offering and to default offering for participants that want to hold those values.

                                                            And what we've heard from the sponsors, what we've heard from surveys, what we've heard from participants is that they also believe, and I think our statistic is 74% of plan participants believe that companies that provide clean water and energy present growth opportunities. So that's interesting. Even the shareholders are believing that these are compensated factors. And then similarly, another statistic is 62% of workers overall are concerned about ESG records of the companies they invest in. People want to save. And what we're hearing is people want to save in investments that align with their beliefs. And so that's going to help participation, it's going to help savings, and that is what we need to do in terms of meeting a successful retirement for our share holder.

Jenna Dagenhart: And finally, Kim, as you look ahead, how do you see target dates evolving? Where do you see the industry going from here?

Kim DeDominicis: I think first of all, it's certainly really exciting to think about how we can continue to help our clients along their retirement journey. Certainly over the past 20 plus years that we've been managing target date strategies, we've evolved, we've done so as we've seen technology evolved. Obviously the market has evolved. The very world that we're all in has certainly evolved over time and changed. I think that's likely to continue going forward. And so it's important for us to be very thoughtful in the overall evolution going forward for future generations. I would say one area that we think we're likely to see advancements connecting potentially target dates with retirement income would be an example. Also, we think that there's likely to be advancements in personalization in the context of a target date strategy as well.

Jenna Dagenhart: Well everyone, thank you so much for joining us. Great to have you.

Chris Sharpe: Great to be here.

Jeremy Stempien: Thank you.

Chris Sharpe: Thank you.

Kim DeDominicis: Thank you.

Sarah O'Toole: Thank you.

Jenna Dagenhart: And thank you for watching this Target Date Funds Masterclass. Once again, I was joined by Kim DeDominicis, multi-asset portfolio manager at T. Rowe Price. Sarah O'Toole, institutional portfolio manager at Fidelity Investments. Chris Sharpe, Chief Investment Officer, Multi-Asset Portfolios at Natixis Investment Manager Solutions. And Jeremy Stempien, Portfolio Manager of the Prudential Day One funds at PGIM. And I'm Jenna Dagenhart with Asset TV.

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