MASTERCLASS: Target Date Funds - December 2018

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  • 57 mins 38 secs
As the markets these days become more volatile, it seems an opportune time to revisit what Target Date Funds. Three experts in this topic join together to discuss how to maximize investment returns, how to use Target Date Funds, and what innovations are on the horizons.

  • Chris Nikolich - Head of Glide Path Strategies (US)—Multi-Asset Solutions of AllianceBernstein

  • David O'Meara - Senior Investment Consultant of Willis Towers Watson

  • Ellen Lander - Principal & Founder of Renaissance Benefit Advisors Group, LLC




Laura Keller:   We're always thinking about ways to help our audience maximize their clients' investment returns here at Asset TV. Target date funds, one option that's available to most every retirement saver, is something that we like to chat about whenever we can. As the market these days becomes more volatile, taking dives down and some bobs upward, it seems an especially opportune time to revisit what target date funds are, how to use them, and what innovations are on the horizon.

Laura Keller: I'm pleased to be joined today by a portfolio manager and two consultants to discuss all of this. To our Target Date Funds Masterclass, please welcome Ellen Lander, Principal at Renaissance Benefit Advisors. We also have Chris Nikolich, Head of Glide Path Strategies in the U.S. Multi Asset Solutions Group at AllianceBerstein, and David Omeara, Director of Investments, Willis Towers Watson. Thanks you guys for joining us today.

Ellen Lander:   Thank you.

David Omeara: Thank you.

Laura Keller: Thank you. Let's dive right in. Chris, you're our portfolio manager on the panel today. Can you start us off just by explaining a little bit, not so much about what target funds are, but really understanding how we can use them in today's environment? Given where we are in the stock market, for example, whether it's time for investors to really be looking at them.

Chris Nikolich: Sure, Laura. I think that's a great question. I think the point you made about today's environment is really important. We've had a market that's been fueled by central bank activity, and quantitative easing. Stocks have returned basically 10% a year for the last decade. Bonds have returned close to four. That's not what we're gonna see over the next decade. There's not a lot of things I could say with certainty, but that's absolutely one of them.

Chris Nikolich: I think from a target date fund perspective, is your fund built to deliver return and risk control in an environment where you really don't need it? Where both stocks and bonds go up every year. We've had a 30 year bull market with falling interest rates, or is your target date fund positioned to deliver growth through using more diversified asset classes, but also providing risk control as we needed in late '15, '16, earlier this year, and again what we're seeing in October and November?

Laura Keller: David and Ellen, you want to weigh in on that too?

David Omeara: Yeah. Essentially target date funds aren't about market timing, they're about taking an appropriate amount of risk at the appropriate time in someone's life. Whether the markets are up and down, we think that having, as Chris said, a risk controlled investment such as target date funds makes sense for a lot of investors, especially if they don't have strong views on where the market is today, and where they see the market going.

Laura Keller: Especially if they don't have those strong views.

Ellen Lander: Completely agree with that. Target date funds, despite whatever the market is doing, are really terrific types of investments for so many of us. People who simply have trouble making investment decisions, or I'm gonna confess, people like me who are knowledgeable about the markets, but we don't have to the time to ...

Laura Keller: To watch them every day.

Ellen Lander: Watch them, and make all the moves. We can be sitting in a meeting when the meeting if falling apart, and this gentleman should be making those moves. We have to pay attention. Whatever the markets are, I'm a huge believer in target date funds. Help a lot of people.

Laura Keller: Right. Well thinking of that, Chris, since you are our portfolio manager in the room, you mentioned that you don't think that the heydays of good times necessarily are here to stay on all markets. What is your outlook for the next say 10 years?

Chris Nikolich: As I was talking about earlier, we've seen double digit returns in equity markets. On a nominal basis, so before inflation, we'll probably see returns that are 3% or 4% lower than that over the next 10 years. For global sovereign bonds, not three and a half or 4%, but more like 2%. That's a really difficult environment to deliver the growth that participants need.

Chris Nikolich: Also, think about bonds that are a key point of risk control in a target date fund. If they're going to deliver little real return over the next five to 10 years, then they'll probably do a worst job diversifying equity risk because yields are so low to begin with, that leads you to have to, in my view, incorporate and think about additional forms of diversification to deliver value to participants.

Laura Keller: David, you're nodding your head on that point. I know we'll talk about that a bit later, but just a preview from you.

David Omeara: Yeah. As Chris mentioned, the equity markets have performed quite strongly since the global financial crisis. Going forward, it's highly unlikely that we repeat that kind of performance. Similarly, on the bonds side, we had bonds rallying for a great number of years. That's not going to happen going forward. We think it's kind of hit bottom around the world, they've ticked up a little bit in the states, offering up a modest amount of value, but that's not true in a lot of other developed markets.

David Omeara: Having portfolios that are restricted to stocks and bonds only, and not allowing for a broader opportunity set makes the forward looking outlook not look very strong for those limited types of investors. We're pretty strong proponents of opening up the toolbox and looking at some alternative assets to include in target date funds.

Laura Keller: We'll pick up on that diversification point later on, but go ahead, Ellen.

Ellen Lander: Yeah. We would agree. I mean it's times like this I'm so glad I'm not a portfolio manager. But yeah, when we've worked with clients on target date funds, and we think it's key to have a lot of diversification, also tactical strategies. Yeah, alternative investments we think are key, and just broad diversification with a fixed income because that is a scary asset class going forward.

Laura Keller: We'll see

Ellen Lander: We may well be wrong.

Laura Keller: May well be. Possibly. But in terms of where we're at today and how people are using these target date funds of this juncture, Ellen, I know you and I have had some conversations on this.

Ellen Lander: Yes, this is one of my favorite topics. Within the industry, we use terms that we get so comfortable with. We've stopped with terms like glide path, and target date fund. We know them inside and out. What we found, as we've been working with clients, and doing metrics, and diving into the usage of target date funds, now why do we do that? Because we're trying to match our clients with the appropriate target date fund. One that has similar characteristics, similar philosophies.

Ellen Lander: What we found was almost disheartening, and that was how participants are, shall we say misusing target date funds. What we're talking about is participants who are investing in several tranches, or participants who are investing in target date funds and core funds. It gets into a discussion of is that strategic, or is that confused? We are believers that it is confused. When you see that kind of behavior, you have to conclude that as an industry, maybe we have not really defined what a target date fund is, and what it does for you.

Ellen Lander: To me, when somebody is investing in several tranches, what they're not understanding is how diversified target date funds are. They've been told, "Don't put all my eggs in one basket, therefore I'll buy four or five different tranches." That's, you know, I

Laura Keller: just to explain that the tranch also means the year in which you are meant to retire.

Ellen Lander: I'm sorry, that's the term I'm using. Yeah, so you'll see somebody in a 2020, 2030, 2040, 2050. Plus some other core funds. I have to believe that we need to conclude that's ... I see you smiling. You finding that as well? Yeah.

David Omeara: Absolutely.

Ellen Lander: It's telling.

David Omeara: We've done plan reviews with a number of clients, and it is interesting when you do see that [inaudible 00:07:58] type of behavior where participants are equally allocated to every fund in the lineup, including all of the target date funds.

David Omeara: There is certainly an amount of participant education, or investor education that needs to be done. But I think, on the other side of things, target date funds do a great job for people who aren't trying to over manage it, or who aren't trying to take too active of a role where it gets people who often times didn't want to be an investor, didn't choose to be. The benefit design made them be an investor, and it allows them to get to an approximately a good risk level at an appropriate time in their life.

David Omeara: For people who don't actively invest in target dates, or at least the end investors, they're the ones who are the best off, the ones who are naively just investing in target dates. Target dates do a great job for them. But unfortunately for participants or investors who have limited knowledge, they can do more damage than they can good. Target date funds can't solve that problem as far as investing goes.

Chris Nikolich: That's where I think there needs to be a combination. There can be the auto features, the auto enrollment, auto escalation for the naïve participant that just will allow themselves to be defaulted. That's also where communications and working with plans comes into play because we know education on itself and communications tends not to move the needle much on participant behavior, but there has to be a combination and an understanding of what people have, and what that target date fund is going to delivery, and how they should use it.

Ellen Lander: Exactly. Exactly.

Laura Keller: Well let's educate though, here. 'Cause that is part of our apparatus, we can, we have the space to do that. How should investors think about it? Should they just be ... I feel like David, what you're saying is, "Put your money in one, let it be. Don't try to mess with it too much. That's the point of a target date fund." But am I right? Tell me more.

David Omeara: No, I think that's essentially right. There is the discussion of which fund to be in, and different fund providers have different levels of risk, different levels of diversification for if this is in a defined contribution plan, then the plan sponsor owns that decision and the participant just has to pick which fund they should be in, which largely is whatever fund is named closest to their retirement date. If they're gonna retire in 2045, or expect to, they should be in the 2045 fund. To the extent that they then look at the risk level in that fund, and they think that's way too risky, or not risky enough, they can always move five years in either direction to move that risk level slightly.

Laura Keller: They should start by looking at that potential retirement age if they actually know what age that may be, but then ratch up or ratch down, depending on the profile of the fund.

David Omeara: Yeah, exactly. That's generally how the target date funds are designed and meant to be used. Although, that doesn't necessarily solve all of the ways in which participants might use them. But yeah, that's the general idea of it.

Laura Keller: We always use the term glide path. We know what that is. But for the nominal person who isn't really understanding what that is, define that for me too. Is that something that has any innovation or any changes coming around the corner that people should understand, in the way that we think about it in this space?

Ellen Lander: We try to avoid using the word glide path. Again, it's an industry term. It's lingo. I'm not sure it means much to people. My concern is always that put five people in a room, there may be five different understandings of what a glide path is. We simply say, "The amount of equities that is within that portfolio." That's what it is. That's what a glide path is.

Ellen Lander: Then we try to educate people that ... We've been using the word naïve, and I actually prefer to use the term that I think most of us are actually not that naïve. I think many of us are either disinterested or it's just really inertia. That's where target date funds really, really solve the problem.

Ellen Lander: But the glide path is how much equity is in that portfolio. I love what you were saying because we try to educate people, that just because you're 40 years old doesn't mean you have to be in that portfolio. If we can get people to understand what's under the hood, how you've built it, what are the building blocks in that portfolio, how much equity you have, and then almost pick it as comfortable with your risk, not so much your retirement date.

Ellen Lander: Again, I use myself as an example. I invested in a target date fund that's designed probably for an 18 year old, because I want a lot of equity. But education is the key.

Chris Nikolich: I think that's an important point too, as I think about the design and management, but also the communication to tie it to the goals.

Chris Nikolich: Early on, even if I don't say glide path, it's an age appropriate asset allocation that is focused on delivering the growth that you typically need when either you're 18, or your circumstances weren't you wanting a higher level of growth exposure, but you're also willing to take on a higher level of risk. For the typical participant, as they move through life, it would benefit them to have that trade off. I'm willing to trade off some additional growth, and lower that risk exposure at the same time. That's what a glide path is doing.

Laura Keller: Are there certain ... When we think about these different tranches, whether it is 2060, whether it is 2040, is there any consideration around fees and how they're constructed? Does that play into it at all? I'm wondering if, for example, equities maybe could be more expensive or could be cheaper depending on what you're putting in. If you have a bigger slice of the portfolio dedicated to that, therefore you'd have less in fixed income, but I'm not sure which would one would be more expensive. Is that something that people should consider at all?

Ellen Lander: Want me to jump in?

Laura Keller: Sure. Anybody can jump in.

Ellen Lander: I mean, that's on the front end, in working with our plan sponsors and choosing what is the most appropriate target date fund for the plan, and their employees. Fees are important. Where I get a bit disheartened in our industry is there seems to be a feeling that cheap is good, and why we're seeing so much money drive to index target [crosstalk 00:14:23] date funds.

Laura Keller: Class A.

Ellen Lander: Yeah. I think that actually can be a fiduciary breach in itself because nothing in ERISA says you need to buy cheap. If you recognize how the portfolio manager is building the target date fund, are there alternative investments in there? Is it more heavily invested in equities? Is it more heavily oriented towards non U.S.? All of that comes at a price.

Ellen Lander: If the fees associated with that target date fund are reasonable, in light of how the portfolio manager has built the portfolio, sure it's gonna be more expensive. It doesn't mean that it's worse. When we're speaking with participants, they are actually looking at net investment returns anyway so much, because we spend so much time analyzing target date funds, we all know that some of the "more expensive target date funds" are actually the best performing ones, relative to "cheap [inaudible 00:15:18] passive".

Laura Keller: Well, that's active management versus passive management I suppose.

Ellen Lander: I'm still a believer, okay.

Chris Nikolich: There's the more expensive but really important diversifying asset classes as well. We'll talk a little bit more about diversifiers. But from a sponsored point of view, there has to be a focus on the explicit fees, but also the value for money. I think the market has leaned a little too much on the explicit fees. It's been an market environment where people really haven't suffered for that because the cheap beta.

Chris Nikolich: If I could have built a two asset class target date fund with U.S. large cap and core bonds, that would have been perfectly fine over the last 10 years, but that's not the environment that we're in today. People should be willing to pay for diversification, active fixed income. Those are important considerations in today's environment.

Ellen Lander: I would also add ... Well, I'm so sorry.

David Omeara: No, just to jump in there, piggy back, active management is important, and there is a rule. However, the way that the defined contribution industry has evolved is that the majority of assets are with very few players.

David Omeara: The largest target date fund providers are dominating the market. By in large, they are passively tilted or oriented. Not exclusively, but many of them are. They're able to then add that scale, they can drive fees down even lower, which makes active management even harder to justify. But I'd also say that in defining contribution, asset managers have had a really hard time beating their benchmarks.

David Omeara: Research that we've looked at have shown that 85% of equity managers underperform on a net of fees basis. Now maybe that's the market environment in which those assets have been invested. Going forward perhaps active management's going to perform better, but we think that beating a benchmark net of the management fee is actually pretty tough. To have all of the skillset reside across all asset classes under one firm, which is how most target date funds are designed, is near impossible, we think, over the long-term, for that manager to outperform net of fees.

David Omeara: We're big proponents of if you want active management in the target date funds, you want to have an open architecture type of solution, whether it's built by the plan sponsor with the help of an advisor, or whether it's with a fund manager that's opened up to third-party assets.

Ellen Lander: Although, that open architecture adds a lot of expense.

David Omeara: It can. Yup.

Ellen Lander: Yeah. What we've found ... I mean, there's so much appeal to the concept of an open architecture target date fund. I think all of us would agree. Maybe even you would agree ...

Chris Nikolich: Oh, absolutely.

Ellen Lander: that there's no asset manager that will excel in all sectors of the market, and yet what we continue to find is that despite the appeal of an open architecture, the risk-adjusted returns, they're not enhanced. I think that has to do with the correlation, how do you correlate all those different managers? Do you have [inaudible 00:18:27] positions? Then you lose your tactical strategies.

Chris Nikolich: Let me touch on that point, 'cause we at AllianceBernstein have a pretty unique view, not to talk about product, but just we believe in greater diversification, we believe in open architecture, and a mix of active and passive. None of those are really provocative statements, but for target date funds, they kind of are.

Laura Keller:   Chris, you just launched one, right? I mean, not to talk , but that is something that you have just recently encountered yourself.

Chris Nikolich: Yes. I guess just is four years ago, so we've built a pretty good track record. Our custom strategies go back to 2005. We really have one philosophy. When you talk about the cost, I think there's the cost for active management. But there's the cost of those diversifying asset classes that can be really important. From a multi-manager point of view, nowhere else in multi-class asset portfolios, endowments, foundations, defined benefit plans, even core menus that both of you are helping clients to build, you see an all single manger lineup. Why is that acceptable in target date funds?

Chris Nikolich: I think part of the reason where some of them have performed well is maybe they've had a bias that's particularly helped them in the current environment. It's been either more U.S. oriented, it's had a growth bias until recently. That's been one of the most significant period of growth outperformance that's helped them as well. But what we tend to see, when we look at single managers who are correlated performance number, correlated alphas, where given a common research platform, one CIO, they're tying into the same economic research, those strategies do really well at the same period of time where they do less well. There can be periods where they're doing phenomenally well, but that's a riskier exposing participants to and those strategies are correlating on the downside. That's not something we believe in.

Chris Nikolich: Then the other point, I just wanted to touch on, which is also really important in being tactical, or what we would call dynamic, we have no problem into implementing that with a multi-manager strategy. For the most part, we're making our tactical or dynamic implementation decisions with the passive portion of the glide path, so we're not disrupting anyone, we're not selling out of a manger with. The point in time they have a great alpha opportunity, but I think we've been able, and I think the market can find a happy medium between an all or nothing approach. We believe in that philosophy.

Ellen Lander: Right. But I think we're also discussing different ways to build an open architecture portfolio. It depends on the size as well. I guess what I was ... Not I guess. What I was leading are the open architecture portfolios where a manager is building it from the core funds within the lineup. We're finding that actually is not working very well.

Chris Nikolich: There I would agree with you. I think one, it's a pretty limited universe of funds. But two, if I'm a portfolio manager and I'm building from the core options, I have one hand tied behind my back because I want to use a number of asset classes, and I think we all would, that I wouldn't want to give the participant the opportunity to put all of their money into. I think that's really important. What's the pond you're fishing in as you think about those strategies and those asset classes.

David Omeara: Yeah, I would agree with Chris on that, that the core menu often times are built with very risk controlled funds, funds that don't deviate from the benchmark by too much. But our research has found that actually in order to generate outperformance, you'd need funds that are taking risk relative to the benchmark. There will be volatile relative to the benchmark.

David Omeara: A lot of the DC industry believe that participants are gonna misbehave, and they're gonna sell when a manager has underperformed, and buy a manger that's recently outperformed, only to have that performance reverse once they become invested. To alleviate that problem, defined contribution plans largely use benchmark hugging type of investment funds where if you were to build a portfolio of funds, you're willing to take on and if you know those fund managers, and their styles, and when they're gonna outperform, and when they're gonna underperform, the person managing the target date fund or that multi-asset portfolio more generally will be able to understand that the managers risk balance those risk within that total portfolio so that when you combine all of those strategies you get to a very risk controlled ultimate solution, but each of the components might be taking a significant amount of largely independent risk, which cancel each other out when you get to the total portfolio. Hopefully what you're left with is outperformance without the risk.

Ellen Lander: A typical core menu just simply doesn't have enough asset classes.

David Omeara: Agreed.

Ellen Lander:There's gonna be asset classes that you want in a target date fund you would not want to put into a core menu. So yeah. Both approaches work.

Laura Keller:This is definitely a healthy and vibrant vein that we've tapped into here. Let's keep going with that momentum, 'cause we do want to talk about some alternative investing, for example, other ways to get that diversification benefit that isn't really currently available to most plans.

Laura Keller: David, I know you've done some research around this. It's something you have looked at a lot. Having the ability to have maybe target date funds invest in hedge funds, or private equity, or even real estate, which is something I think you are seeing a little bit of happening.

David Omeara: Yeah, we're seeing a little bit, a few plan sponsors or a few funds out there that are using alternatives. But it's certainly not widespread. Earlier this year, we, well done some work with Georgetown University on a paper to explore including alternatives into target date funds, to see if we can drive better retirement outcomes for participants. To, they can.

Laura Keller: They can spruce up target date funds. Good to know.

David Omeara: They can. The improvement can be rather significant. Now it takes using multiple different asset classes, so we looked at adding hedge funds, direct real estate investments, as well as private equity, which is maybe one of the hardest ones to deal with because you have a lot of cash flow considerations that need to be managed.

Laura Keller: With the long lock-up periods.

David Omeara: Very long lock-up periods, and you have daily pricing and daily liquidity being offered to the end users. How do you manage a fund knowing that the participant can liquidate an entirety in a day?

Laura Keller: Whenever they want.

David Omeara: The issue really becomes, not every participant is gonna liquidate 100% on any given day. What we've seen is that target date fund investors, by in large, are set it and forget it. Once they're in, they tend not to move around much. There are a few who move in and out, and play a tactical game. But by in large, they're being defaulted in, and they don't want to manage their assets, so they're gonna let it sit there.

David Omeara: In large part, target date fund assets act like other institutional asset pools. There's a pretty consistent cash flow. Cash flow, it's very strong for the late dated funds, or the younger participants, and it turns negative as people get closer to retirement. But that's not unlike whether you have an endowment or a defined benefit pension fund that has cash flow need and you manage those needs with other asset classes. You don't need 100% of the portfolio to be liquid on any given day.


David Omeara: The market has evolved to the service providers in the market, whether it's record keepers, custodians, and advisors can help fill in the gaps and administer such products. I think that there's a great opportunity in defined contribution right now to include some of these alternative assets. They get used all around the world in all different asset pools. It's really only U.S. DC plans that don't use them.

Laura Keller: That choose not to. Well Chris, does that excite you? Does it scare you? What kind of thoughts to do you have about that.

Chris Nikolich: It excites me. There's various levels of if we want to use that word alternative. The private asset classes that David, you were alluding to, we use some of them in our custom strategies. But that doesn't mean even in a packaged vehicle, a 40 Act fund, or a CIT, you can't add additional forms of diversification where we're believers in utilizing long-short strategies, or market neutral strategies.

Chris Nikolich: Even strategies I wouldn't call, and I don't think anyone would call alternatives, but you just don't see them in target date funds. Low volatility strategies, dividend oriented strategies, what we would call defensive equity strategies. That's important for someone who's approaching retirement. Global hedge bond strategies in today's interest rate environment, where I could diversify the economic and interest rate risk, but not take on a lot of currency risk. You don't tend to see those in target date funds.

Chris Nikolich: High income strategies, think of emerging market debt and high yield that can diversify fixed income, can provide some real return, all of these are strategies that, to David's point, are time tested but you tend to not simply see them in many target date funds. I think for most of them, it's because they're built without an open architecture framework. As a portfolio manager, I'm limited to using the strategies that my firm offers if that's the structure of my fund. That's not, in my view, the most efficient way to build a portfolio.

Laura Keller: But that's why I think it seems target date funds are unique because you're able to manage ... I mean, I don't know that we are necessarily recommending that every planned participant put every cent of their money into a target date fund. Maybe we are, maybe we aren't, but it does allow that person to get access to these different classes in a way that they wouldn't be able to otherwise. You don't have to choose to put money into a stock fund, into a bond fund, and many other funds that maybe your plan doesn't even have. The target date fund has the ability to go across and choose some of those assets, like a fund to funds, is how I like to think of it.

Chris Nikolich: You're absolutely right. David mentioned earlier, some of the fear of putting these strategies that are more diversifying on the core menu, is people chase performance, they'll buy them and sell them at exactly the wrong time. You don't see in mass that type of behavior in target date funds, partly because of cash flows, they're investing their own assets every other week, they're getting a match that's smoothed some of the market volatility and people stay the course. Having these long-cycle diversifying investments that are alpha oriented in many cases can really benefit them in the long-term.

Laura Keller: Anything you want to add on that discussion, Ellen?

Ellen Lander:No. I would completely agree. I mean diversification is the more the better. I think there is an openness, even with [inaudible 00:29:38] closed architecture you're starting to see them sneak out with some alternative strategies. Yeah, it's entirely appropriate.

Laura Keller: Do you think of diversification also in the thought process of ESG? Are those kinds of things that you think about too? I mean some target date funds are looking into ETFs as well. Is that something you consider to be diversifying, or that's a different realm?

David Omeara: I'd say that is a little bit different. I think ESG type of investment philosophies are well suited for a target date. It is focused on a long-term evolution of the market, what is tomorrow's world going to be? That's the kind of overlay that ESG provides.

David Omeara: We're not big proponents of ESG funds necessarily, that only looks at those types of things, but we certainly want ESG to be a component of a portfolio manager's repertoire in how they're evaluating securities. It really does help provide an overlay of risk embedded in any one company, or whether it's a stock or the bond, and understanding what are their philosophies on different issues. Actually, we've seen it makes a big difference

David Omeara: Companies that focus on ESG, they have better retention of key employees, people are motivated to show up to work, people want to do good. People work because they need income and basic needs, but people want to be energized about the work they're doing. A company that has ESG friendly policies are really at the forefront, tend to have more motivated employees, and those employees perform better, and therefore the company performs better. We want portfolio managers to be looking at those things when they're evaluating securities.

Laura Keller: I like your point too on the longevity factor of the ESG investments as well, for target date funds. But let's bring it back to today's market. We started off there, but I think in each part of our conversation it's helpful to think about it more.

Laura Keller: I want to go back to Chris, and just think a little bit more about from that portfolio management perspective, what you're doing to be a little more defensive, and to limit the downside risk that I think we all think is coming at some point here.

Chris Nikolich: A couple of things are structural. One, we're big believers in additional forms of diversification, which has benefited participants in this recent environment. Not just having a traditional stock and bond beta, having those diversifiers, having defensive equities, diversification within fixed income using global strategies. Those are all really important.

Chris Nikolich: Ellen, you mentioned earlier the benefits of tactical and what we would call dynamic. That's something else we're implementing in this environment. We have a somewhat different philosophy than many. We're not making those tactical decisions to try and juice the returns, we're trying to maintain the same return that someone could have otherwise realized, but cut off the tails. Deliver that return with more consistency and less risk. If I can do that as a portfolio manager, that's really important for the end user, the plan sponsor, as well as the participant.

Chris Nikolich: I think that the diversification, the last part is in the implementation. I think I mentioned earlier, it's that risk budget, maybe having a little bit more passive exposure where alpha is harder to source in U.S. large cap, saving that active feed budget for small cap for emerging markets, for real assets, and for those diversifying strategies that simply don't lend themselves to passive management.

Chris Nikolich: The final point I'll make from what's helping in today's environment, while we're big believers in a diversified multi-manager strategy, my and AllianceBerstein's core competency is in asset allocation. We think the manager selection decision should be outsourced, the same as you see with a lot of the large plans that David, I think you were alluding to earlier.

Chris Nikolich: I don't want to have a conflict where if my portfolio manager leaves, I'm making the decision whether to hire or fire them. That should be a third-party decision when I think about what will benefit the end user the best.

Laura Keller: Interesting. Okay. I mean, I think all those things you talked about for hedging is very important, probably more in today's market than other times.

David Omeara: I'd say as far as being dynamic, a lot of investors and portfolio managers think of it as how much risk to take, and taking more or less risk. But we tend to think of it as where to take the risk, not ratcheting up risk when it's undervalued, or taking it down when things are rich. But it's where is the opportunity to get paid to take risk, and navigating that.

David Omeara: We're not big proponents of moving the risk level around, but we're more focused on having a set risk budget, and then investing the assets in order to meet that you're getting best compensated at that level of risk.

Chris Nikolich: I would agree with you, where we're not seeking to move the risk level around, but sometimes the market environment does that. I've designed a fund for someone close to retirement that is a lot more risky today than it was six moths ago. If I want to delivery that same level of risk, the same level of potential downside, it behooves me to take a little bit of market risk off the table. I'm not trying to manage their risk level to different levels, but to keep it the same when the markets change.

Laura Keller:How often do you have to go and recalibrate that then, Chris?

Chris Nikolich: We'll look at the numbers on a daily basis. We'll have a specific, what we would call dynamic meeting at least on a monthly basis. We'll go through periods where for a couple of quarters, there's not material changes that we're making. More recently, we've made a change, and a week and a half later we've taken a little bit more risk off the table to deliver that level of consistency to perform to participants that we need to. There's not a set frequency, it's all dictated by the market environment.

Laura Keller: What tools are available to yourself, and chime in here Ellen and David, on portfolio construction innovation? Are there certain things that can help, tools that can help people like Chris these days, that maybe weren't around a few years ago perhaps?

Ellen Lander:I'm gonna defer to you. I don't manage the money. I'm very, very lucky. I just get to pick apart performance, but ...

Laura Keller: Well I'm thinking of analytics providers, for example, certain kinds of things, or you can even have feedback coming in from the plan participants themselves, the plan sponsors too, to say, "Well this is what we're looking more forward to having next time."

Chris Nikolich: I think a lot of that feedback relates to that end net of fee performance that the participant is realizing and living through. Many of them, they don't want to know how the watch is built, they just want to know what time it is, and that it works.

Chris Nikolich: The feedback is, and what we try and take to heart is you need to participate in those [inaudible 00:36:48] bull markets that we've seen for much of the last 10 years. However, you have to be effectively positioned to control risk on the downside that we've seen recently. We've seen a couple of pockets of in the last few years, and we'll probably see more of. I would define risk as equity market sell offs, bond yields rising, and inflation shocks, whether they're from CPI, or what we've seen more of recently, or the trade wars, and the reaction overseas despite the truths we may see as of late.

Chris Nikolich: I think there's a lot that we have done to incorporate that to the management of a portfolio. I think having one that only focuses on the growth environment, where the risk control environment, just won't deliver what participants need over multiple cycles.

Laura Keller: When you tweak those portfolios, when the market conditions are changing, are you having to look more closely at the plans that are closer to that retirement date. Say the ones coming up 2020, for example, than you are the 2040s with the expectation that the market will bounce back at some point?

Chris Nikolich: It gets to David's point of what are we trying to do? Where do we want to take either more or less risk, or more or less exposure? Is my focus on controlling downside risk, strategically much more for the person who's close to retirement? Absolutely. It's the same thing on a tactical basis. When we move and underweight the risk position, we'll do so more in the 2020 and the 2015 fund, than we would for the 2040 or the 2050 fund.

Chris Nikolich: Now conversely in 2017, where we were modestly overweight for much of the year, overweight non-U.S. equities, but we were hedging the currency risk, there it's the opposite. There if I'm looking to actually improve the returns in the short-term, I'll take a little bit more of a deviation for the 2050 fund. There's never I think a one size fits all answer. It all relates to the environment that we're living within.

Laura Keller:   And dynamic, as you say.

Chris Nikolich: Yes.

Laura Keller: Let's think about some of those uses. Because you know, as we've touched on here, but not exactly stated maybe, there are different uses for this. I mean some people are looking at this as retirement income. I know David, when you and I chatted before, you talked about folks that remain invested until they basically are kicked out of the vehicle that they're in. How do we think about uses for different participants? It must be different for some of them.

David Omeara: Absolutely. The design of target date funds is really to provide retirement income for folks, so a savings vehicle and then have them transition into retirement income. Now we think it works really well as an accumulation vehicle. Everyone pretty much want their money to grow in risk controlled manner. People aren't terribly different in that, but once they get closer to retirement, their uses for the money actually do differ widely. Some people have taxable assets that they're gonna spend first, and so they're gonna leave their qualified assets invested until they get forced out at age 70 and a half. There's others that are gonna liquidate rate at retirement and roll it over into some other account so that they can merge all their assets together because they might have their money in different pockets. They prefer it if it's all in the same pocket.

David Omeara: It's difficult right now in target date funds. They have to be build for different potential uses. For plan sponsors, they've got to get people to retirement and with a reasonable amount of risk so that people feel comfortable retiring from the company when they're still being productive. Companies I don't think want people staying past when they want to be gone. People become less productive when they're not able to retire. When they have financial stresses they become less productive.


David Omeara: We did a global work study that indicates people who have financial problems tend to be less productive in the work place. They're distracted, they're worried about other things. Certainly that's an issue with people not being able to retire on time.

David Omeara: I think that employers need to think about getting people to retirement, but the funds need to meet that objective. But also be at a reasonable risk level so that people can remain invested in the funds, and they're not at disadvantage by staying in target date funds, as opposed to moving into other vehicles.

Ellen Lander: One of the things that you want to look at, there's a multitude of different target date fund out there. Everyone has a different philosophy, everyone has a different strategy. As a consultant, what we try very, very hard to do is to ... The plan sponsor has to pick one target date fund. It has to go with one philosophy. It really just comes down to trying to match it with the behavior of the workforce. The plan sponsor's almost trying to predict, are people going to take the money out or are they going to leave it in there?

Ellen Lander: Again, it's education. One of the things that's we're trying hard to do is to get people to see the benefits of actually staying within the plan, whether you're working or to. We're actually starting to see more and more terminated employees, or retired employees leaving their money, instead of taking out lump sums. I don't know if the new deal, well the dead deal, how fiduciary rule is helping with that. But people can be very, very benefited with the right plan sponsor who's monitoring the investments with the right portfolio manager. People can simply buy better, I believe, in a retirement plan, that's hundreds of millions of dollars, than they can on their own buying from a broker.

Ellen Lander: We try to do as much metrics as we can, and as much education we can. Do we have a workforce that's older or younger? That's going to help what type of target date fund do you buy. Do people tend to leave their money in the plan? That will allow you to look for a portfolio manager or a target date fund that's actually a through retirement. Do you have people yanking money out? That will help push.

Ellen Lander: It's very, very difficult job for a plan sponsor to deal with all these different target date funds that say this is the right one for us. But we try to educate people, the advantages of staying in the plan through the low cost, professional monitoring, professional management, that they can take installment payments. They don't have to take a lump sum, it's probably a bad idea to take a lump sum. That's what you got to do.

Chris Nikolich: From a portfolio management point of view, I'm managing a portfolio with these diverse [crosstalk 00:43:36] participants' behaviors.

Ellen Lander: All these rogue investors.

Chris Nikolich: I'm building a portfolio that if someone leaves their money in and has reasonable saving, I'm striving to deliver a pretty high level, let's say 85% of their pre-retirement income that they can use is it a draw down vehicle. I know some of their ability to do that will be based upon things outside of my control, how much they save. I'm also trying to minimize the likelihood of a large loss, and I would define that as 10% or greater at the point of retirement because somebody may have just joined the plan five years ago, somebody may be rolling their assets out of the plan, which I also don't think the asset location should drive the asset allocation just for the simple reason that someone's rolling out.

Chris Nikolich: I don't think I should bring them down to a very low level of growth exposure because maybe then, Ellen, they'll work with an advisor such as you, you'll tell them they're gonna live another 30 years, and the average stock bond allocation in 401Ks is 60/40. The average stock bond allocation in IRAs is almost exactly the same. It's 61% in stocks, and 39% in bonds. I'm serving both of those types of participants effectively, but part of it goes back to the philosophy of trying to deliver that growth in the long-term, but really being very focused on risk control in these negative markets we've seen recently.

Laura Keller: We don't have too much more time in the panel, but there are two topics I want to make sure we get to. We've been able to talk very thoroughly about where we're at now, what considerations people should be thinking about if they don't have the right idea already. But what about the future? What about where we're heading?

Laura Keller: We talked about customized portfolio solutions, having that customization in the plan. Maybe that's something you guys want to [inaudible 00:45:27] on. Or I'll throw it out there, if you want to talk more about single manager, [inaudible 00:45:32] manger. But think for me one thing as we move forward into 2019, that's gonna be on your calendar or on your client's calendar to think about as far as innovations in this market. Ellen, you want to start us?

Ellen Lander:   No.

Laura Keller:   Well, all right then.

Ellen Lander:   That's an interesting question. I'm thinking like, "Wow, I want to hear the other answers."

Laura Keller: Who wants to start us off then? Anybody can.

David Omeara: I think one of the things that define contribution plans more broadly, and I don't know if we'll solve it in 2019, but certainly continue to work on it is the idea of a decumulation vehicle within defined contribution. Defined contribution was built as a savings program, and supplemental to defined benefit plans. That's largely how it still operates.

Ellen Lander: Completely what it's not.

David Omeara: It's not what it is. We think that more and more participants are gonna be in the DC only world. They're not gonna have a defined benefit plan, or at least not a substantial one, if they do have one. Moving forward, they're gonna be reliant on turning their savings into income. We've seen a lot of research that indicates that retirees generally underspend, they save a lot more than they need to, they make sure that they always have a rainy day fund in case something bad happens, which means that they basically underspend their capacity.

David Omeara: By in large, not necessarily all, there's certainly some people who spend all of their assets and then they're living off of social security, which is another problem entirely. But the majority of savers, they always have to have that savings set aside on top of their income, so they tend to underspend.

David Omeara: We think that there's room for defined contribution to help people actually maximize their standard of living in retirement, which right now we think there are people who are underspending, which means that they're just taking advantage of the life that they have.

Ellen Lander: Now I'm gonna jump in, because I love that. I would almost love to pose a question because I agree with you. It's amazing how much we all talk about people misbehaving and not having money. That is what we are finding, is that people are underspending. It brings to the topic of the escalating glide path where we're starting to see more conversations about increasing equity exposure.

Ellen Lander: The, I'm gonna use the term, glide path has always been decreasing equity exposure, but to your point we are starting to see more and more talk, which is most interesting of increasing equity exposure past retirement. I would love to hear what you think about that.

Chris Nikolich: Sure. Sure. I think on average, you could do better with an increasing growth exposure.

Ellen Lander: I think it would scare people to death, but yeah.

Chris Nikolich: A) I'll agree, but B) people don't live in the averages. In many of the papers, they don't think about the participant. The reason why they typically don't derisk is because of that greater level of risk control. If they suddenly began to derisk, or if you're just unlucky enough that you retired in March of 2009 instead of any other year in the last 10 year period, or you're retiring now, then all of a sudden that upward sloping glide path, which worked great for all of your colleagues, is now a horrible idea for you in the short-term. That's not something I see gaining a lot of steam, as we talk about innovation.

Laura Keller: We had decumulation issues. We've also had the upward glide path. What would your future look like, Chris?

Chris Nikolich: I think we'll continue to see those institutional best practices be incorporated into target date funds. They tend not to be well diversified, or multi-manager. I think some of the innovation we'll see in the future is away from that all or nothing we have today, where there's target date funds, and there's managed accounts.

Chris Nikolich: Managed accounts are great for the people who are financially sophisticated and engaged. That's not the typical participant. But what if I could build a target date fund, or multiple glide paths for someone who approaches retirement. I would agree, it's not really important for the 25 year old, not just based on their age, but based on their salary, based on their savings rate, based on their accumulated wealth, based on how much stock the own, and based on defined benefits or not. They could not engage, and we could pull all this information on their behalf.

Chris Nikolich: I think that's where we'll start to see some future innovation in target date funds. It's not throwing out the simplicity of a target date fund, it's just enhancing them where we can get more information.

Laura Keller: data.

Ellen Lander:   Yeah, we're also seeing the talk about bringing annuities into target date funds, which sounds tremendously appealing if it could be done correctly, if we can get some guidance from the Department of Labor, and if we could bring the cost down.

Ellen Lander:   The thing, as you're talking about managed accounts, a great idea and we're finding people are just not engaging with them. What they're doing is buying a high price target date fund because they're not providing any outside information. But you're right, if we can get people to really understand what these are, what managed accounts are, what they need to do, we'll be in a good place.

Laura Keller: Right, right. Well the future holds what it will hold, but one thing that we know is where people are at now, which again, we spent some time talking about. But Chris, I want to leave this with a research report that AllianceBerstein has recently done, Inside the Mind of Plan Participants. Confidence was something that was rising higher. I wanted you to talk about that a little bit, see what you found.

Chris Nikolich: This was a survey we had done earlier in the year. If we took those confidence numbers today, maybe they would be a little bit different. But there was a huge jump, 47% of participants said that they were confident in their retirement and the outcomes they would have versus only 32% last year, which also was an increases over the last prior years.

Chris Nikolich: But when we dig into the data a little bit, there's a pretty big tale on either side. When we ask about peoples' standard of living since they've retired, half of them say it's the same as what they expected. I'd say two-thirds are generally happy, but a third of participants it's lesser materially less than what they wanted. There's still more that we need to do as an industry to deliver value for them.

Chris Nikolich: One other question that was somewhat enlightening is we asked them what their key goals were. Providing income for retirement was at the top of the list. That wasn't too surprising to us. But I think what was a little surprising is that was the top answer for 56% of participants. A couple of years ago that number was 71%. What are we seeing more people focus on today? It's enjoying life, and paying for health care and medications doubled from 12% just a couple of years ago, to 24%. We're seeing a lot more focus on paying for those other expenses, one of which is healthcare in today's environment.

Laura Keller: Yeah, it seems …need to be some solutions around that. But I just want to follow up. When I was looking through your slides on that study, as we said, the confidence level was rising to this high in more than 13 years. But people were still expressing reservations about the timing of their retirement. I'm wondering why that is if they're confident, but yet also the timing is off for them. Do you have any understanding of why that might be?

Chris Nikolich: I think some of that is a lack of clarity in terms of when they'll be able to retire. We know that people tend not to be able to plan more than 10 years in advance. For younger participants, will I retire in 2060? They don't have a lot of insight into that decision, and I think that's leading into some of it.

Chris Nikolich: The other thing we saw, and this is the 13th year we've done this study, for the first time that the top answer, in terms of their main concern, was social security and lower benefits. That was the number from 40% of the participants. We're seeing a little anxiety about some of that formerly three-legged stool. Nobody has defined benefits anymore. People are going to have to wait longer for social security benefits that will be less, and that's causing a lot of anxiety with participants.

Laura Keller: Is that similar to what you, Ellen and David, you're seeing as far as when you talk to plan sponsors and plan participants too?

David Omeara: Yeah. Plan participants, they've been focused on accumulating assets. They don't know how to draw it down. They don't know how much they can safely draw down. Often times they have to keep working as long as they can. However, a great number of people retire before they actually expect to because they either fall into disability, or they have to retire to take care of an elderly parent or another family member, or they get laid off and they can't get another job.

David Omeara: Best laid plans in preparing for retirement and often times get cut a few years short, which leaves them, while they may have thought they were going to be prepared, they end up not being prepared because you actually need to be prepared a few years before you think you're gonna need it. Which is one of the challenges I think that savers end up having, where when we were in the defined benefit plan world, those people were largely taken care of. In defined contribution it's a little less friendly.

Laura Keller: Definitely different. Ellen, last point on that.

Ellen Lander: No, I was just gonna say, couldn't agree more. That's why I think this whole concept of automated, getting people in there, getting people in at the right rate, getting your plan sponsor to design their plan, to make it friendly place. I'm actually optimistic. We tend to work with a white collar type of group. But I am optimistic. We're seeing younger people are much, much better savers than we baby boomers. I think people are finally getting the message. I think that's where our industry has really, really helped a lot. We just having to keep doing it, and educating, and keep that money flowing, keep investing well.

Chris Nikolich: One point that makes me optimistic in terms of the behavior of sponsors is we're seeing a little bit of movement, or a pretty substantial amount of movement away from some of the legacy ways of sourcing target date funds.

Chris Nikolich: Back in 2009, 60% of the target date funds were from the plan's record keeper. Unfortunately, a lot of those decisions were probably made to select a record keeper for their recordkeeping services, and just take the target date fund along with it. Well that's no longer 60%. In 2015, that dropped to 40%. In this fee sensitive environment, in 2009, 27% of target date funds were implemented with collective investment trusts. Now that's over 50%.

Chris Nikolich: We're seeing a lot of movement, not just in let's put my assets into target date funds, but let's make sure we have the right one. The right one might not necessarily be from my plan's record keeper. That makes me optimistic about the market environment as well.

Ellen Lander: You should be. That's one of my favorite questions, "How did you pick this target date fund?" You get the committee looking at each other like ...

Chris Nikolich: That's not a good answer.

Ellen Lander: Not a good answer. Exactly.