History of Target Date Funds
June 24, 2019
Remy Blaire: Welcome to Asset TV. This is your Target Date Funds Masterclass. These types of funds are offered by an investment firm and seek to grow assets over a specified time period. The structuring of the funds address an investor's capital needs at a future date. The asset allocation of a target date fund gradually grows more conservative as the target date edges closer.
Remy Blaire: I'm joined by Wyatt Lee, Portfolio Manager of Multi-Asset at T. Rowe Price; Rich Weiss, CIO of Multi-Asset Strategies, and SVP and Senior Portfolio Manager at American Century; Chris Nikolich, Head of Glide Path Strategies U.S. and Multi-Asset Solutions at AllianceBernstein; and Sean Kenney, Managing Director and Head of Defined Contribution at MFS Investment Management.
Remy Blaire: Gentlemen, thank you so much for joining me for today's Masterclass. Well, when it comes to target date funds, many people might see it as a simple investment solution. It does offer convenience, but there's a lot to digest, and a lot for both clients as well as advisors to know about target date funds.
Remy Blaire: Let's dive in and start out by looking at glide paths. Now, Wyatt, I want to start out with you. What do you think are some important considerations for glide path construction?
Wyatt Lee: Well, I think your introduction was great. For most people, they look at target date funds and think of them as being really simple investments, but they're actually very complex under the hood. The problem we're trying to solve with a glide path has to address not only the mix of what is happening in the capital markets, and our long-term expectations for asset classes may interact with each other over an investor's life cycle, but we also have to take into account the characteristics of the investors who we're trying to serve, including their demographics as well as their behavioral preferences.
Wyatt Lee: But at the end, when we're thinking about glide paths, we really think about two important considerations. First of all, we think about the objective. From our perspective, the objective that we're trying to solve for, the outcomes we're trying to lead our participants to, are the most influential part of glide path design.
Wyatt Lee: From our perspective it's impossible to design something if you don't know what it's ultimately trying to achieve. When we think about this, we think about it in terms of an individual's preference between achieving a sustainable income stream over a long horizon, versus the off-side of that, which is the variability of the balance around retirement.
Wyatt Lee: Second key thing we think about is for the portfolios to be robust. What I mean by that is we want them to work across a wide range of possible situations. We're building portfolios for a wide swath of the population who have very heterogeneous characteristics. They have different goals, different preferences, and we want to build something that works well across all of them. Ultimately in this way we think we can assure that we can deliver an appropriate outcome for the most people.
Remy Blaire: When you look online and try to get a better handle on what target date funds are, you discover analyzers on different platforms, but we know that each firm has different philosophies. So, Rich, I want to move on to you. With you, what is an optimal glide path?
Rich Weiss: There is no single objective optimal glide path. I think we'd all agree on that. Wyatt laid out the various risks and parameters and variables that go into glide path design.
Rich Weiss: We like to think of glide paths as analogous to clothing, a suit, for example. It's what suit best fits or suits you. It's marrying or matching the glide path design to the specific plan-sponsored demographics. The age and wealth cohorts, the savings rates, the wealth levels, the risk tolerance, et cetera. It's an, "It depends," question for the optimal glide path.
Remy Blaire: Well, I think that was a very helpful analogy for the viewing audience.
Remy Blaire: Now I want to move on to you, Chris. You're the head of glide path strategies the AllianceBernstein. Do you have anything to add to that before we take a look at the environment we're in right now?
Chris Nikolich: You know, from a glide paths perspective in terms of what's optimal, I think I agree overall. I think it's getting that balance of growth and return and risk control right, and there's no one glide path that can do that best in all markets. How do you balance both of those appropriately, I think is critical to not delivering the optimal results, but really delivering the risk control and the wealth-accumulation that participants need.
Remy Blaire: Of course, whether we're talking about target date funds or any other investment vehicle, we need to take a look at the investing landscape. Let's start out by looking at the environment we're in right now. It's obvious that there is uncertainty that's affecting the broader market and there are a lot of fundamentals that people are paying attention to.
Remy Blaire: But Chris, can you talk about some of the trends you're seeing in the market today?
Chris Nikolich: Remy, in terms of the trends that I'm seeing in the marketplace, I think investors, advisors, plan sponsors are seeking more institutional ... or maybe I might call them more sophisticated structures. They're seeking to incorporate asset classes beyond traditional equities and fixed income.
Chris Nikolich: Fees have been a big focus, and they're seeking lower their fees, whether it be through the utilization of more institutional asset classes, or vehicles beyond just a '40 Act fund, or maybe a combination of both active and passive.
Chris Nikolich: As I talk about passive, that's been a big trend in the marketplace in a rear-view mirror. To give people credit, cheap and passive and simple really hasn't been a bad place to be invested. But when you think about the drivers of the capital markets over the last five or 10 years, that's not the market environment that we expect over the next 10 years.
Chris Nikolich: I'm seeing a greater appreciation of the benefits of active management, whether it be to deliver return in a low-return environment or control risk. I don't think a simple, passive and cheap allocation, while it's done well historically, will deliver the return nor the risk control that participants need going forward, and the buyers are beginning to acknowledge that.
Remy Blaire: The next question, Sean, could you tell me about the shifting demographics here in the U.S. workplace, and how that's impacting the way that plan sponsors are thinking about target date funds in their plan?
Sean Kenney: Remy, there's two core trends that we're seeing from a demographic perspective. The first has to do with Millennials, which we all love to take about the Millennial generation. The second has to do with what we call the approaching retirement demographic, the 50- and 60-year-olds.
Sean Kenney: With regards to Millennials, what we're seeing is that they represent a pretty small percentage of overall 401(k) assets, around 10% of overall 401(k) assets, but they are now the largest generation in the workforce in America. The implications of that are they're starting to wield a little bit more power in terms of benefits that plan sponsors and companies are trying to offer, as well as the way that plan sponsors are thinking about designing and structuring and communicating their retirement program.
Sean Kenney: A great example of this, and I think a manifestation of that, is ESG, because one of the things that we know with the Millennial generation based on employer survey results and data, is that they want to align their employer and their investments with their personal values and beliefs. ESG in our world, from an investment perspective, is just a manifestation of that desire, that demand.
Sean Kenney: So, we actually think, as we talk with plan sponsors and consultants, it's a bit of a challenge to implement ESG products into DC structure, particularly in this country with some of the Department of Labor implications and regulations that have been put forward. So, we've been spending a lot of time with our clients talking through, how can you satisfy the demand that the Millennial generation has, to align their personal values and beliefs with their investments, while also making sure you're managing your fiduciary responsibility of achieving strong risk-adjusted portfolios in your plan? That's one trend that we're focused on and we're out spending some time with plan sponsors on.
Sean Kenney: The second has to do with this approaching retirement demographic. The late 50-year-olds, early ... and 60-year-olds. Unlike the Millennials where they're close in terms of the workforce, they're about a third of the workforce just below the Millennials. They represent about 60% or a little bit more of the 401(k) assets, so they're a huge part of the 401(k) structure. They are meaningful to employers because employers, as they think about workforce planning, are really trying to get these people, these participants, to the finish line.
Sean Kenney: As we think about that particular cohort, one of the things that's important as they've accumulated this big balance that they've spent many decades saving and growing, is how do you actually de-risk that portfolio in a thoughtful way and manage some of the sequencing risk that that generation's going to be really focused on?
Sean Kenney: We actually think this is a really important time, where we are in the markets, and where we are with this demographic, to really zero in on the fixed income allocation and target date portfolios, and making sure that we're looking ... As Wyatt said, under the hood at the structures, both the design of it, the risk management of fixed income in general is a big topic.
Remy Blaire: Indeed, when we're talking about investing, especially for retirement, we know it's the baby boomers or Millennials that get plenty of attention. But you brought a lot of important points to the forefront. Wyatt, how do you see recent increases in market volatility affecting target date funds, and also for those approaching the onset of retirement?
Wyatt Lee: I would say as I've been talking to clients, not only just right now while volatility is increased, but really, it's dating back to the fourth quarter of last year, volatility has really been top-of- mind. The current market environment, what's going to happen going forward, and how is that going to impact the savings that I've already accumulated, are huge questions we're hearing.
Wyatt Lee: I think it's a good opportunity to step back, though, and realize that although we're talking about market volatility reemerging, market volatility is always part of investing. If you're building a strategy that's supposed to last multi-decades, not only through a savings horizon but also into a retirement horizon, it's really important to incorporate market volatility into your research to make sure that your portfolio is well set up to meet its overall objectives at the end of the day. Recognizing that with a forward-looking basis we're going to have periods of volatility.
Wyatt Lee: What I do notice, though, is often in the target date space where we think of them as very long-term objective-oriented products, there is such a large focus on short-term, point-and- time risk, and I'm not sure all the investors in target date space understand the trade-offs that actually exist. With such a viewpoint on what's the downside, what if the market turns down when I retire, the natural inclination is I should be in a more conservative strategy around retirement. I want to de-risk so I don't have a large loss right at the point where I'm not saving anymore.
Wyatt Lee: What gets lost sometimes is that has, or can have, some potential unintended consequences because if you think of the way target date funds are constructed, those that generally have a more conservative allocation in and around retirement, have generally had a lower equity allocation, a lower growth allocation, for their entire horizon. There's an opportunity cost for that. By not having as much in growth assets, you're potentially not compounding wealth as much, you're not building your nest egg as large.
Wyatt Lee: We think the more appropriate way to think about market volatility is a holistic viewpoint. What strategy is ultimately going to get me to a better place when I ultimately retire? You could very rationally come to a conclusion where I may be willing to sacrifice the potential of more market volatility around retirement so that I could have more growth assets going into retirement, and I can compound my assets little by little over time, and actually retire with a much larger nest egg, which can set you up for a better retirement over the long term.
Remy Blaire: I think those are some very important points. Nowadays advisors as well as investors out there have access to so much information, and with all the breaking news they might hear about what's happening with one type of financial investment product, and there could be a panic reaction. I'm sure people in the viewing audience who are investment professionals, that tip will be very helpful to them.
Remy Blaire: Now, Rich, moving on to you. What do you think about the current market and the outlook going forward? How does that factor into your outlook for target date funds?
Rich Weiss: Well, I don't think there's any question we're in a highly atypical economic cycle, and I don't know anyone who would think that the next five or 10 years are going to look exactly like the last five or 10.
Rich Weiss: With that said, clearly, we're in a global economic deceleration period right now. But I would caution anyone to anchor their lifecycle investing strategy, or target date glide paths, to any one particular forecast. You want to incorporate a number of different scenarios so that you can cut the widest swath and make sure you guarantee a successful retirement for the broadest number of participants. That includes a number of different market and economic scenarios, a number of different savings and withdrawal rates, a number of different investment horizons, et cetera.
Rich Weiss: To do this we use Monte Carlo simulations, which is a fancy term for taking a computer and running amok by making it run hundreds of thousands, if not millions, of different simulated future environments, changing the inputs one at a time. That way you get a sense of how you can build a glide path and a structure that accommodates the broadest number of participants over the broadest number of potential market environments.
Rich Weiss: So, we don't pretend we have the crystal ball, and we set the glide path with inputs and inform it with today's environment, but we don't bet the ranch on it.
Remy Blaire: Staying with you, Rich, I do want to talk about risk management. As you mentioned, we are in atypical markets right now. We've had a 10-year bull market, but the financial crisis wasn't that long ago, and for people who had been nearing retirement during September 2008, that wasn't an ideal time. When it comes to the biggest risks to consider when it comes to lifecycle investing, what do you advise?
Rich Weiss: Well, there are many risks, obviously. I would argue the biggest risks don't necessarily come from the market, and they don't even come from the target date providers. But in target date space the overarching risk is what's known as longevity risk, the risk of outliving your wealth or running out of money in retirement.
Rich Weiss: In order to solve or minimize ... To solve for the problem of longevity risk or minimize it, there are many different sub- components of that risk. So, it's market risk or tail risk or inflation and interest rate risk, as you near and enter retirement, become more prominent, or sequence of returns risk, et cetera. These all factor in. But I'd say far and away the biggest risk in lifecycle investing is really on the participant. It's the risk of not saving enough. Not having a high enough savings rate.
Rich Weiss: What is that magic rate? It depends, but I would say this, whatever you think it is, do more. The fact of the matter is, if you have not saved enough over your working life, it really doesn't matter which target date fund provider you choose, because we're not going to be able to save you from your own poor savings habits.
Rich Weiss: On the other hand, if you've saved well enough, more than enough, it also doesn't matter which target date fund provider you choose, because you're pretty much going to successfully retire. It's in that middle range that the differentiation really comes into play.
Remy Blaire: I think those are very important points. Now, I want to get your perspective, Chris, from a portfolio management perspective. What are you doing in today's market environment when it comes to limiting downside risk?
Chris Nikolich: There's a lot of risks, Remy, that we seek to limit, but specifically for downside risk part of it is moving beyond the typical asset classes, and traditional stocks and bonds. Within equities, we're incorporating what we'd call defensive equities. Think of low vol or dividend-oriented strategies that maybe don't fully capture the upside in the first quarter. Maybe they only capture 90%, but if they only capture 60 or 70% of the downside in the fourth quarter that's really important, not for the 25-year-old, but for that person who's 50 or 60 and approaching retirement.
Chris Nikolich: Fixed income, as was mentioned earlier, is very important as well. We're using unconstrained bond strategies ... Think of cash plus 3%. That can serve the role of bonds in a portfolio, which is to diversify equity risk, but do so in a way that doesn't expose the participant to the same sort of duration risk that they'd have in a typical bond portfolio. Or use global fixed income strategies that diversifies economic and interest rate risk, but if I hedged the currency, I'm not taking on a lot of additional currency risks that may overwhelm what I'm trying to do in the safe portion of the portfolio.
Chris Nikolich: Alpha, as I mentioned earlier, is really important. We believe in the incorporation of alpha from different investment managers to help limit downside risk in what may be a correlated alpha, all the strategies are relatively performing good or bad at the same time. It feels really good when they're out-performing, but if they're all under-performing at the same time, by diversifying that I could limit short-term risk as well.
Chris Nikolich: The final thing is not having a set-it-and-forget-it mentality. Having a, what we would call, dynamic or a tactical asset allocation strategy, which is to reduce some of the exposure to equities temporarily when the downside is more significant, as it was in the fourth quarter of 2018. Then re-risk early in 2019 so you can have the benefit of the long-term growth potential but manage some of those hiccups a little bit better in the short term.
Remy Blaire: Well, those are some good points. I want to focus on what you think in a general perspective. How do you manage risk in a target date product light?
Wyatt Lee: I think risk management in a target date product is a little bit different than traditional risk management. Risk management is an important part of any investment process, but in more traditional strategies the focus is really one dimensional. It's the focus on loss. How can I prevent loss?
Wyatt Lee: In target date space risk takes on many forms. Rich talked a lot about this earlier. You have the idea of longevity risk, inflation risk, market risk, behavioral risk. Not just participants not saving enough, but participants moving at the wrong time. When you think about this, often the solutions to one of these types of risk actually will start to increase some of the other risks, and so it becomes a balancing game. We really think in this game it's important to balance the risks relative to the goals you're trying to achieve.
Wyatt Lee: If you think about what risk really is, it is about exposure to the possibility of an unwanted outcome. The question has to be is, which of these is the outcome that I really don't want to occur given what I'm trying to achieve? Understanding what circumstances represent an unwanted outcome, and then building a strategy that can seek to minimize that risk is really the goal of any target date fund.
Wyatt Lee: I think the most obvious of these is the balance between short- term market risk and longer-term longevity risk. The simple way to think about this, if I want to reduce short-term market risk, I can build a more conservative portfolio. Less growth assets, maybe more fixed income, but then what that is probably going to do, it's probably going to increase your exposure to longevity risk because I don't have enough growth in my portfolio to potentially meet my needs over that long horizon.
Wyatt Lee: And then the opposite is just as true as well. If I have more growth assets in my portfolio because I have an income orientation, then that's going to increase short-term market risk. The question then becomes, of these, where is the trade- off? Which metrics do I want to use to evaluate the risk and how do I manage to them? Because if I choose the wrong metric relative to the goal I'm trying to achieve, then that's when I actually bring on risk because I'm under-invested in the manner that I need to be to achieve my long-term objectives.
Remy Blaire: Well, gentlemen, I think you all highlighted a lot about risk management. Before I wrap it up for this section, Sean, I want to bring it back to you when it comes to plan sponsors. Is there anything in particular that you think plan sponsors should spend time on understanding when it comes to fixed income allocation within target date funds?
Sean Kenney: I agree with all of my colleagues here that it's really about the choices that plan sponsors and their participants have to make around the trade-offs of the risk exposures and what they're looking to accomplish with their target date portfolio.
Sean Kenney: One thing that we are highlighting with our clients and consultants today is looking closer at the fixed income allocation, because so often in the target date conversation, we focus on equity and fixed income, and the ratio between those two asset classes. Those are mega asset classes and there are sub-asset classes within them that we believe is particularly important for that approaching retirement demographic.
Sean Kenney: As you're thinking about those trade-offs, there's a number of different objectives that fixed income will play along someone's journey, from total return to capital preservation to inflation protection to income generation. So, particularly for that 50-to- 60-year-old cohort, we believe it's important to spend the time to understand, not only as they de-risk and move more toward fixed income ... Whatever level that is. There's a lot of different levels of fixed income as people approach retirement. But within that, how are we thinking about addressing longevity risk through total return?
Sean Kenney: It's not just about diversifying equity risk. I think a lot of times the fixed income allocation is really thought of purely as just diversifying away from equities. There's actually asset classes like global credit, high yield, emerging market debt, and even TIPS portfolios. Some of these asset classes, sub-asset classes within fixed income, are more total return oriented, slightly more correlated to the equity markets, but it's the trade-off between, do you want to take the direct equity exposure, or you want to take some fixed income exposure that has more total return potential?
Sean Kenney: We're advocating for a little more of an emphasis on that and looking at the broader tool kit within fixed income that your target date manager is using.
Remy Blaire: Did you want to chime in?
Rich Weiss: If we can get back ... Remy, you asked earlier, and I think Wyatt spoke to target date evaluation ... I think it's incumbent upon us as professionals in the industry, and intermediaries, and the analytical firms, and plan sponsors, to step up our game there. I think the analytics have woefully lagged the industry in terms of the sophistication of these structures.
Rich Weiss: In fact, comparing vintage by vintage is crude and misleading in many cases. Just looking at simplistic metrics like return or even risk-adjusted return ... Target dates are a process, by definition, a lifecycle series of investments. So, much like a motion picture, you have to watch the movie. Nobody compares movies by saying, "Let's look at the first five minutes of this movie and compare it to this five minutes of other movies," and then ranks the movies. You have to watch the whole picture, and in the same way, target date strategies are dynamic, they're lifecycle strategies. We need metrics that are aimed at measuring that, not at simply a horse race between your 20/20 vintage and ours.
Remy Blaire: Well, I think that's a very helpful comparison, although sometimes I think my attention span has gotten shorter in this modern age where even five minutes seems like a long time, but indeed that's a very important point when approaching this type of investment.
Remy Blaire: Now that we're in a late cycle economy there's a lot of caution that prevails even when it comes to target date funds. Chris, you hinted on this earlier and talked about multi-managers versus single managers. But with this structure, why should advisors as well as plan sponsors consider this variation, and how can participants benefit from additional asset class diversification?
Chris Nikolich: It's my belief that whether you have any sort of multi-asset class fund you should have incorporated into it best practices. If you think about the management of endowments or foundations or defined benefit plans, even core menus, they're all multi- manager structures. I'm fortunate enough to be sitting here with some representatives from great firms, but how could one firm be best in class in everything? That's why you typically see multi-manager strategies except in many target date funds.
Chris Nikolich: I'd say the other element that I alluded to earlier is that notion of alpha correlation. With a strong-willed CIO, the same economic research, maybe some of the same fundamental analysts, you tend to see strategies moving somewhat in lockstep, doing better or worse at the same time, and that can also be diversified with a multi-manager structure.
Chris Nikolich: I'd say the other point relates to the asset allocation. As an asset allocator, if I'm limited to only what my firm is offering, or maybe offering as a '40 Act fund, I feel as though I'm trying to do my job with one hand tied behind my back. Why shouldn't I be able to use the strategies that are out there for all to use, and have a broader pallet to build what I think is a more efficient target date fund? You mentioned participants earlier, which I believe, especially in today's economic environment can lead to both better risk control and better long-term return generation over time.
Remy Blaire: Moving on to you, Wyatt. How can financial intermediaries help plan sponsors evaluate the suitability of their target date product for their participants?
Wyatt Lee: That's been a big question we've heard a lot, especially after the Department of Labor put out their tips a few years ago. As plan sponsors see more and more of their total plan assets accumulate in their target date family that they've chosen, we're having more questions about, "Is the product that I chose several years ago ... does it continue to be right for what I'm trying to achieve on a going-forward basis?"
Wyatt Lee: Unfortunately, I think one of the first steps that gets taken is almost backwards. Investors start thinking about the right target date fund based on the fee level, or is it an active/passive, and they start from the bottom up instead of from the top down.
Wyatt Lee: From our perspective, glide path suitability and target date suitability really isn't a very significantly different question from overall target date design. The first thing we think people should do is identify what are the goals they want to achieve. What are the outcomes I want to take my participants to? What role do I want to play in their retirement?
Wyatt Lee: Once plan sponsors can start figuring this out with the help of intermediaries, they can start thinking about what metrics they want to pay attention to. Are they income metrics, are they volatility metrics, how many they want to pay attention to, and then start evaluating which target date fund actually helps them meet their goals.
Wyatt Lee: This is actually a big portion of work that we've been doing recently. We've had several surveys of plan sponsors across the size spectrum and worked with them to try to understand what they're trying to achieve and how their goals have actually evolved over time. We're actually very positive on the results because we're really starting to see alignment of what plan sponsors are trying to do with really the intent of the defined contribution system, which is to provide income over the long term.
Wyatt Lee: There were two key questions that I actually found most interesting. The first, we asked plan sponsors to choose what they were trying to do from an outcomes perspective. How much did you value giving individuals the opportunity for long- term income replacement versus the other side of it, trying to minimize downside? Overwhelmingly we saw the plan sponsors were focused on income. I think this has probably been a change as defined contribution become much more a pillar of retirement over the long term versus 10, 15 years ago where it was more supplementary in nature.
Wyatt Lee: The other question we asked that I found was really interesting, was we asked plan sponsors to prioritize the risks. What risks are you most concerned about? Overwhelmingly we saw they were concerned about longevity risk. Short-term concerns like market risk and downside risk had a very low acceptance rate. So again, we think this is really important in terms of we're starting to see plan sponsors' goals being aligned with what we're seeing in the target date space so that they can really use target date funds most effectively to get their participants to their retirement goals.
Remy Blaire: Wyatt, before I move on from you, I want to ask about performance. Could you tell me a little bit about some of the key things that financial intermediaries can look at to evaluate the performance of their clients' funds?
Wyatt Lee: Sure. I think performance evaluation has always been a difficult task in target date space. You have a lot of providers who have a lot of differences. You have complex products, and you have designs that change over time, which makes it much harder to evaluate them than if you were to just evaluate a traditional stock or bond fund.
Wyatt Lee: When I think of it, I would recommend two things. First of all, I would look at a range of different benchmarks. I would look at a range of performance evaluation criteria. We typically think about our performance relative to an industry benchmark like the S&P target date series. Then we look at it relative to a proprietary benchmark that matches how we invest, and then we look at ourselves relative to peer groups. From each one of those comparisons we try to glean insight, and then by getting insight across all three of those simultaneously, we can get a much more comprehensive picture [inaudible 00:32:07] what relative performance looks like.
Wyatt Lee: The second thing I would think to offer is, take into account the value proposition of the target date fund when you're evaluating them. What I mean by that is, all of us offer different strategies. It's going to look very, very different. That means our results could be different in the same market environment. That doesn't necessarily mean one of us is doing something wrong. If we have different objectives and different glide paths, one who is managing a portfolio based more on volatility or downside protection should under-perform in a rising equity market. Understanding that linkage to how are you performing relative to your value proposition I think is really important. If you can do these two things well I think you'll be well placed to understand how your relative performance fits in with your long-term goals.
Remy Blaire: Well I think you made a lot of important distinctions that will be very helpful for the viewer. Before I wrap it up for this section, approach to investments, Sean, I want to ask you about your market expectations and what implications that you're watching right now, especially when it comes to defined contribution plan sponsors and participants that are invested in target date funds?
Sean Kenney: Our view is that we're in a lower for longer environment, both from a return and a yield perspective. I agree with my panelists here that I wouldn't use that information to make tactical decisions with it, but I do think it's instructive in terms of how we should think about investing to meet our participants' long- term goals. What I mean by that is, if you compared a 60/40 equity to fixed income portfolio going back 10 years ... This is as of the end of December 2018. On average that 60/40 equity/fixed income portfolio would have returned about 7.7%.
Sean Kenney: Based on our long-term capital market expectations, we build 10-year forecasts and use that to help clients model different scenarios for their plans. Based on our 10-year forecast, that same 60/40 allocation over the next 10 years will yield you about 4.6%. That's a pretty big delta between what we expect the markets to generate going forward versus where they were in the past. Again, we don't use that in any way to make tactical decisions in portfolios nor would we advocate that. But what I do think it highlights is that gap is critical for participants as they try to save over the next 10, 20, 30, 40 years to accumulate and then de accumulate their portfolios.
Sean Kenney: What that tells us and what we're talking to our clients, and consulting and advisor partners about, is we really need our portfolios to be working harder. What we don't think we should be doing is taking demonstrably more risk just because the return expectation's lower. We just think the portfolios need to be working harder. In our view, that's a really important case for active management as we go forward because active managers do have that ability to out-perform the passive benchmarks, and we do believe that going forward that alpha, the out- performance, is going to be that much more important to helping participants achieve their goals.
Remy Blaire: I think we have highlighted a lot of the risks, but going into the future we don't know what the future holds, obviously. We don't have a crystal ball. Looking ahead, starting with you, Rich, what trends are you seeing when it comes to solutions for retirement income?
Rich Weiss: Ah, retirement income. The Holy Grail for target date structures. That's where all the money is, right around and in retirement. As a first line of defense or first answer, I'd offer that our default in retirement target date funds are an appropriate investment vehicle for most. That's where we are today. But interestingly over the last several years there's been a distinct and decided movement towards more paternalism on the part of plan sponsors, being supported by the regulatory environment.
Rich Weiss: Several years ago, most plan sponsors weren't interested in, and matter of fact, many did not want to deal with employees staying in their plan. Now that's changed. There's a bigger focus on it. In fact, many plan sponsors now are incented to keep those participants in the plan, so there's been a greater focus. What we're seeing ... Two different avenues among others seem to be getting the most push, and that is income funds, other options in their line up to work hand-in-hand with the target date structure so it could feed off into a potential income fund that might fit that particular investor, depending on their savings and withdrawal needs and rates.
Rich Weiss: The other is a link with the insurance industry that is an annuity structure. The most logical one is the one that the regulatory environment specifically outlined, which is a deferred income annuity, what's known as a longevity annuity. It's basically an option on your life. How do you think you're going to live, and if you live past that, can you at least get that spending funded? So, linking up that way with insurance companies, with annuities, makes a lot of sense for the laypeople and also for the academicians. So, we expect to see a lot more movement on that score.
Remy Blaire: Rich, it's interesting you brought that point up regarding annuities because the SECURE Act was compared to the change we saw back in 2006 with our target date funds. But a lot can happen in 10 years, so Chris, I want to ask you this question regarding your market expectations for the next 10 years and how do you see it being different from the previous 10 years?
Chris Nikolich: Not surprisingly lower, Remy, and as was mentioned earlier ... I'll focus on equities for a moment, but this is the first 10-year period, as of the end of March, that doesn't include the global financial crisis. Late 2008, early 2009. What does that mean? That means that [Aqui 00:38:04] returned annualized 11.9% per year, so almost 12% per year in global equities. Most people, or many, use the S&P 500 as a proxy for equity returns. 15.9% per year over the next 10 years. I don't think anyone is going to think that that's the expectation going forward.
Chris Nikolich: So what do we do in this environment? For us it gets back to that institutional, more sophisticated focus, and moving beyond traditional asset classes, both to control risk, but also to deliver the returns that participants need. That's my job as a portfolio manager. Part of the job, as was said earlier, is participants will have to save more.
Chris Nikolich: When Wyatt was answering the question about performance evaluation, he mentioned a lot of great lenses that people should use, but I think all of them are historical. I don't think anyone disagrees that the market environment is going to be different in the next 10 years. Advisors need to work with their provider, or develop a framework on their own, to help compare different target date funds and different structures on a go-forward basis, because if you're only looking historically ... And history is going to be so different and, frankly, better off probably than what we're going to expect, then using a historical lens doesn't give you a good perspective in terms of making prudent buying decisions.
Remy Blaire: Well, Chris, I'm sure a lot of investors out there won't like the reality of having to save more, but that might be true when it comes to looking into the future.
Remy Blaire: I do want to go back to you, Sean, and ask for your perspectives. What do you see as one of the biggest concerns, when it comes to consultants or plan sponsors, that they may have when assessing a target date fund manager?
Sean Kenney: Well, I want to thank Wyatt for a perfect segue because that actually gets to ... We believe target date management, in essence, is all about risk management. It's about risk management for participants. We actually performed a survey about a year ago, and we learned that about a third of consultants that evaluate target dates on behalf of their plan sponsors are very concerned about their ability to assess risk management.
Sean Kenney: This was actually troubling. What we learned through that survey was that it's not so much about the equity/fixed income glide path piece of it, it's more about the underlying components that they have trouble understanding. It's about how the underlying funds within the target date series ... How that risk is managed. It's about how the procedures and policies are put in place to manage risk in the portfolio. It's that next level down of risk management.
Sean Kenney: Our contention would be, if you really want to spend the time to understand the differences between target date portfolios ... Certainly you want to assess the glide path and the asset allocation and the sub-asset allocation, but spending the time to really understand how risk is managed across the funds within it and then in aggregate and at an enterprise level with that organization, are really essential.
Sean Kenney: When you think about so many consultants and advisors struggling with that, I think it's incumbent on us as the managers to help them understand what we do and how we do it and how important it is, because fundamentally, managing lifecycle strategies over decades on behalf of our participant clients is all about managing that risk on their behalf.
Remy Blaire: Well, Sean, I think that's very helpful for the advisors that are viewing this right now.
Remy Blaire: Chris, I want to bring it back to you. When talking about these types of target date funds, many tend to associate them with a mutual fund series. Are there any other vehicle structures that lend themselves to provide similar benefits?
Chris Nikolich: There are, Remy, and I think we're seeing an evolution in the marketplace. Over the last five, seven years, we've seen a tremendous growth in custom strategies that now, in our view, accounts for approximately 20% of the overall target date assets. Separately, if you look at CITs, or collective investment trusts ... 2012, they represented about 19% of target date fund assets. As of the end of 2018, it's 39%.
Chris Nikolich: So, why are we seeing some of that migration? I mentioned cost as an issue earlier. CITs tend to have a lower cost governance structure and they're more efficient. They can use mutual funds, but they could also use separate accounts or collective investment trusts. In today's environment that is focused on fiduciaries doing the right thing, if you could get a more sophisticated structure that's similar, maybe, to that '40 Act or that mutual fund, and you could implement that in a more cost- effective manner, that's pretty much a lay-up to lead to some potentially better results. That's why we're seeing that growth and I think we'll continue to do so.
Remy Blaire: Well, gentlemen, we've been able to cover a lot of ground regarding target date funds, but before we wrap it up for the masterclass, I do want to open the floor up to this discussion. When it comes to these types of funds, there are a lot of myths out there, and especially for investment professionals as well as their clients, there might be a lot of points that aren't so well represented. So, opening the floor up to all four of you gentlemen, what are some myths out there that you want to address?
Sean Kenney: I'll start. I'll start on the end.
Sean Kenney: Can I add two? I'll make them quick.
Remy Blaire: Of course.
Sean Kenney: One is that we don't view that there is an average participant. There are so many. I mean, we've talked about the heterogeneous nature of these plans, and these companies are running very heterogeneous populations and participants. There is no average participant. We spend a lot of time in our industry talking about the average participant, but we advocate our clients to really understand the needs of every participant. That's their fiduciary responsibility to do that. I think sometimes in our industry we spend a lot of time talking about the average, and the average blends a lot of the extremes. I think that's one of the most important one from our perspective.
Sean Kenney: The second would be this notion of risk. We've talked a lot about income and helping people meet objectives, but if you're a defined benefit pension plan and your goal is to reach a funded status of 100%, it's the same thing for a DC participant. We're trying to get them to a funded status of 100%.
Sean Kenney: Early in your life, actually, the riskiest asset that you can hold as a participant is cash because you have 0% chance of being able to grow that portfolio enough over 40 years to meet your funded status of 100%. You need to invest it in things like equities because that's actually going to help you get to that 100% funded status. So, actually, we talk so much about risk in terms of market risk, but in reality, to the participant it's a very different framework that we should be talking about risk in.
Sean Kenney: Then as you get later in life, approach retirement, you've got this big nest egg you spent 40 years accumulating and you're about ready to stop working and earning more money ... Now the risk is you're going to lose half of it by some big equity market pull back, or some 2008/2009 event. Now the riskiest asset might be equities, and the least risky asset might be something like fixed income.
Sean Kenney: So, I think we talk as practitioners in our industry so much about market risk, but from a participant perspective, and if you think about their journey and the objectives that they have, I think we should be considering risk from a different perspective.
Rich Weiss: Diversification. I think there's a myth widely out there that in order to be globally diversified one should be potentially, theoretically, cap-weighted, which would indicate a 50% weighting in the U.S., and 50% outside the U.S. I don't think any of our structures are that diversified outside the U.S., and I think there's good reason for that.
Rich Weiss: Although you may see charts that show that it may increase your risk return trade-off in the accumulation phase, the fact is, the lifecycle investing and target date fund structures are essentially a liability-driven investing problem. That is, you're managing a surplus. In other words, you're accumulating wealth in your working years, and then your liabilities start to accrue in your retirement years when you spend it down.
Rich Weiss: So, if you look at it from that perspective, being overweight in the U.S., what's known as a domestic bias, which is evident, again I think, in all of our structures, is right. It's correct because the thing you're hedging is spending in the U.S., ultimately. If you are working, living and earning in the U.S., and plan to retire and de accumulate or spend in the U.S., the best hedge for U.S. spending and inflation is predominantly in U.S. assets. That's why we have a domestic bias. That's why we're not cap- weighted. It's not because we don't know how to do it, or we're afraid to do it, or it's too risky to do. It's not appropriate in this context.
Chris Nikolich: There's a myth that you can buy a passive target date fund, and that passive target date funds alleviate the risk of the sponsor or the advisor. You can obviously buy a target date fund that's implemented passively, but the same as our target date funds, what will drive the bulk of the long-term results ... the asset allocation. They're different between different passive providers.
Chris Nikolich: If you want the return of the S&P 500 without risk you can buy a passive strategy. You can't do that with a target date fund, nor does it mean that you're going to have the return your participants need or the risk control that they want in the short term.
Chris Nikolich: I think the whole notion of passive being safe, while again, it has been historically in this double-digit equity return and a 35-year bull market in fixed income ... That's been what people have realized, but going forward, I think some people are going to be very disappointed and unpleasantly surprised by thinking they went down a path that was going to lead to less risk. Maybe in the short term it gave them less risk of having a pattern of risk and return that was different than the marketplace, but ultimately their participants will bear the risk of having results that simply were subpar.
Wyatt Lee: The myth I would focus on is about participant behavior. I think there's a viewpoint that participants in target date funds react to market events. What we see is that just doesn't happen. It's been consistently shown to be wrong, but I think many advisors and many plan sponsors are still concerned that if their target date fund posts too big of a loss, participants are going to leave at the wrong time.
Wyatt Lee: We saw it didn't happen in the financial crisis, it didn't happen in the fourth quarter of last year, and it hasn't happened in any of the market downturns in between. The fact of the matter is, most defined contribution participants are on autopilot. So, if we can build a strategy that's appropriate for them, harness that inertia, they're going to stay in the strategy and reap the benefits over the long term.
Wyatt Lee: In fact, we're continuing to look through the data. We actually saw in the few transactions there were by participants, as many were stepping into the volatility and either buying more growth assets, moving to a longer-dated target date fund, as there were who were de-risking. So, the fact that we should be making judgements over the long term based on this myth of participant behavior is one that we need to start ignoring, and getting participants into the right place, and harnessing the behavior that we do see.
Chris Nikolich: If I could just add, I agree with Wyatt. Where I have seen some poor timing, behaviors are not at all from participants but from plan sponsors. I think it's incumbent upon you as the advisors to protect them from making the short-term decision with the one- or three-year rear-view mirror, which does nothing but incorporate they're going to buy high and sell low.
Remy Blaire: Well, gentlemen, it's always great to discuss myths because it does address a lot of the misconceptions out there, especially when it comes to target date funds. Thank you so much for joining me today and thank you so much for your insight.
Rich Weiss: Thank you.
Chris Nikolich: Thank you, Remy.
Sean Kenney: Thank you.
Wyatt Lee: Thank you.
Remy Blaire: And thank you for watching. This has been your Target Date Funds Masterclass. I was joined by Wyatt Lee, Portfolio Manager of Multi-Asset at T. Rowe Price; Rich Weiss, CIO of Multi-Asset Strategies, and SVP and Senior Portfolio Manager at American Century; Chris Nikolich, Head of Glide Path Strategies U.S. and Multi-Asset Solutions at AllianceBernstein; and Sean Kenney, Managing Director and Head of Defined Contribution at MFS Investment Management.
Remy Blaire: From our studios in New York City, I'm Remy Blaire for Asset TV.