MASTERCLASS: Target Date Funds - November 2019

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  • 47 mins 53 secs
Saving for retirement requires proper planning, consistent management and time. Target date funds are a viable option for participants who seek professional management for their retirement assets. TDFs offer retirement savers a simple solution to invest without worrying about allocations, glide paths or rebalancing.

In this panel discussion, 2 experts examine the evolution and outlook for target date funds, and consider the importance of glide path design within a TDF strategy:

  • Sarah O'Toole, Institutional Portfolio Manager, Fidelity Investments
  • Susan Viston, SVP, Client Portfolio Manager, Multi-Asset Strategies and Solutions, Voya Investment Management

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MASTERCLASS: Target Date Funds - November 2019

Remy Blaire: Welcome to Asset TV. This is your Target Date Fund Masterclass. Saving for retirement requires proper planning, consistent management, and of course, time. Target date funds are an option for participants who seek professional management for the retirement assets. In theory, the funds offer retirement savers a simple way to invest without having to worry about allocations or glide paths or even rebalancing.

Joining me to discuss retirement risks, the evolution of target date funds, and the outlook for the industry are Sarah O'Toole, Institutional Portfolio Manager at Fidelity Investments, and Susan Viston, Client Portfolio Manager at Voya Investment Management.

Well, first and foremost, let's start out with the very basics. As with any investment, it's so important to stay on top of risk management as well as fees and asset allocation with target date funds. For a very basic question, can you tell me, how do target date funds work?

Sarah O'Toole: Sure. I think that's a great place to start. At their most basic level, target date funds are designed to help people save and invest for their retirement income needs. Essentially, a target date investor selects a fund based on their target retirement date and the investment manager adjust the asset allocation mix as they move through their life, and typically moving from an objective that's more total return oriented to one that's more focused on capital preservation. These strategies have really been embraced by the market.

We see 90% of plan sponsors offering target date funds as the default investment option in their plan.

Remy Blaire: Now that we've covered that basic question, Susan, I want to move on to you. Why do different target date funds carry different types of risks and can you explain how investment strategies affect the outcome?

Susan Viston: Happy to. I think from a participant perspective, target dates really benefit them because they simplify saving and investing for retirement. But from a plan fiduciary perspective, the selection process is much more complex. The reason for that is because the target date space is very diverse. There's no single benchmark that managers are measuring themselves against, and there are very different views as to what the appropriate allocation is, not only during the savings years but also at and through retirement. Because of those reasons, you can see very different approaches when it comes to target date design.

Take glide path for instance, which dictates what the equity and bond allocation is throughout a participant's cycle. For participants that are early in their career, say a 20, 60 portfolio, the equity allocation can range anywhere from 80% on the most conservative side to close to 100% on the most aggressive side. That actual dispersion increases as you get closer to retirement where the difference between managers can be as high as 45% equity. That's the main reason why a target date design and the approach to targeted design can have a significant impact on participant outcomes.

Remy Blaire: Well, Susan, you touched on a lot of important points and we'll be taking a deeper dive later on in this masterclass on some of the points that you hit. Now, Sarah, back to you, what do you think is the best way to evaluate a target date fund?

Sarah O'Toole: It's a good question because as Susan said, it is a very diverse set of funds in the market. I think the best way to evaluate a target date fund or a provider is really the quality of the management team that's managing the funds as well as the commitment to the retirement space of the overall firm.

Designing a glide path and a strategic allocation for someone who's saving for retirement requires a lot of research and insights. Really over time what's going to differentiate the outcome among all these target date providers is the quality of the investment decision that's made. I think that's one plan advisors can start their due diligence process.

In terms of performance evaluation, we encourage our clients to look over the very long-term because we're investing for multi-decade horizons. Then over shorter term periods, obviously, absolute performance, benchmark relative performance, pure relative performance are all things that people typically look at. Then we also look at risk adjusted performance because our goal is a very long-term outcome, but we're also focused on smoothing the ride towards retirement. So, making it a smoother transition as someone moves from their working years to their retirement years.

Remy Blaire: Susan, you touched on design earlier. What aspects of target date design are critical to consider?

Susan Viston: I think, first and foremost, the most important aspect of a target date fund is how well it suits a participant population. That's not only from a demographic standpoint such as saving rates or salary growth, but also from a risk tolerance and actual behavior factors. I would suggest that when you're evaluating the design features, that you need to do so within the context of the participant population.

I would say the one design feature that probably has the most influence on outcomes is the glide path. That is really for two reasons. One, that's where managers differ the most from each other, but also particularly, near retirement, where managers are very diverse and where you have a high account balance, short time horizon, and where market movements can have a significant impact on outcomes.

When evaluating a target date manager glide path is critical as well as asset allocation and manager selection. Finally, cost but not because of selecting the lowest cost provider but evaluating the value that a target date manager is bringing. Well, it's up to the cost that you're paying.

Remy Blaire: Well, there are plenty of financial professionals watching the semester class segment on Target Date Funds, and their clients may ask them, what are some of the advantages or disadvantages of target date funds? How would you weigh in?

Sarah O'Toole: I think one of the greatest advantages of the target date funds over the years has been the improved asset allocation that participants have benefited from. We've seen over the past decade, given that many plan sponsors are using target date funds as their default investment option, that the percentage of participants who have extreme allocations either having 100% equity or 100% cash has really come down and they have a more disciplined asset allocation strategy.

On the disadvantaged side, I don't necessarily think it's a disadvantage, but one hurdle or something that plan sponsors need to really focus on is education and communication around target date strategies because target date strategies and success in these portfolios really requires a partnership between saving and investing. The plan sponsor, obviously, has a plan design feature that will help and encourage savings.

A participant has to follow a prudent savings approach and then the investment manager is also part of the solution. I think education, around target date and helping people stay on track, is something that rests largely in the plan sponsors' hands and also is guided by many financial professionals.

Remy Blaire: I think you mentioned a keyword there, which is education. What do you think needs to be happening when it comes to target date funds in terms of education?

Sarah O'Toole: I think education really has a broad reaching impact. It can be anything to what is a target date fund, to how do I use it, and how will it help me achieve my goals?

Remy Blaire: As we mentioned earlier before about the glide path, I'd like to move on to that topic. As we all know, target date funds have a glide path. Let's take a look at some of the approaches. Now, Sarah, is the glide path most impactful to the investment outcome of a targeted strategy?

Sarah O'Toole: Yes, it definitely is. The glide path and their strategic asset allocation decision, which is based on very long-term views, is likely to have the most impact over long-term horizons to investors in the strategy. The reason why there's so much focus on glide path design and glide path construction is that reason.

Glide paths vary significantly across the industry, as Susan mentioned a few moments ago, and they really differ along a few dimensions. One is, which asset classes are included. Different managers have different views about what qualifies as a strategic asset class. The pace of change in those asset classes in terms of what's held throughout somebody's life differs among providers and how that glide path changes during the retirement phase is also an area of differentiation.

Remy Blaire: Susan, going back to you within glide path design, how critical is the to-versus-through decision?

Susan Viston: Now, I have very mixed feelings about the definitions of to-versus- through. I think that they're fine if you take them for what they are, which is solely telling you when a target date manager is reaching their most conservative equity allocation. If they're reaching it at the retirement date, then there are two manager. If they're reaching it sometime in retirement, whether that's five years or 30, that's a through manager. And that's simply it.

I don't think it's the only tool that can be used to evaluate assets near retirement. In fact, the best way to evaluate a manager near retirement is to truly understand what is their philosophy and approach to managing those critical assets for individuals as they head into and go into retirement. Not only from a glide path perspective, but also from a sub asset class perspective and what managers are they emphasizing at that stage in an individual's career. I think that's a much better tool than just simply bucketing managers between two and through.

Remy Blaire: Sarah, I noticed that you're also nodding your head. Would you like to weigh in?

Sarah O'Toole: Sure. Yeah. I would echo Susan's comments that to versus through was a classification we saw many years ago, much more frequently. But now I think the due diligence processes are focused beyond that decision of when the allocation in terms of equity reaches its most conservative point and focusing on some of the broader issues that impact outcome outside of that.

Remy Blaire: While we're on this topic of glide path, before we move away from it, what are some of the insights that can inform a glide path?

Sarah O'Toole: Yeah. In building the glide path and the strategic asset allocation for a portfolio, providers are typically leveraging their insights on participants, what they see in terms of behaviors and savings profiles as well as views on markets. So, what is the long-term view on asset classes? How does history play into the view today? Generally, those are two of the big buckets that influence the glide path and strategic allocation.

Remy Blaire: Since you mentioned market, we are well into a bull market and 10 years plus to be exact. But when market conditions are lofty, it's easier to just step away from something like target date funds. But for people who have questions about the long-term, what is the best approach?

Sarah O'Toole: We believe the best approach is diversification. When somebody invest in a target date strategy, they'll likely be with us for many decades. We believe that diversification is the best way to manage the uncertainty they'll face over that period and volatility over that period. Throughout all market environments, we want to have some level of diversification in the portfolio for investors.

Remy Blaire: Well, Susan, we've highlighted the innovations taking place in the target date funds space, but what are you seeing in terms of trends for target date vehicles?

Susan Viston: Sure. I think we're seeing a general preference for lower cost vehicles and the ability to potentially take out non-investment related fees from the expense ratios. That's really leading to two main trends. I think the first is a trend towards zero revenue share classes within mutual funds that really take out revenue share as a way to purely just charge the individual for the investments.

Then second, we see a trend towards collective trust versus a mutual fund. In the past, I think the knowledge around collective trust was limited. I think that there was concerns about added paperwork and the fact that there's not a ticker associated with the vehicle became a headwind.

However, I think a lot of those headwinds are being removed and fiduciaries are recognizing the benefits of a collective trust in that you can offer the same robustness when it comes to target date design, but in a vehicle that could potentially offer a lower cost. I think going forward, you're going to continue to see the shift towards zero revenue share and collective trust vehicles.

Remy Blaire: Sarah, would you also like to weigh in on some of the trends we're seeing?

Sarah O'Toole: Yeah. I think it's important for a provider of target date strategies to provide clients' choice and how they choose to access the strategy. When we started managing target date funds many, many years ago, they were available in mutual fund format. But over the past decade, we've diversified into CIT structures as well.

I think there's just been more adoption because of the lower fee. There's also similar transparency on the CIT side when the participant goes onto their workplace website and can see all the characteristics of the CIT, whereas many, many years ago that may not have been possible without a mutual fund ticker.

But at the end of the day, I think it comes down to client preference. There’re some segments of the market that just really prefer a mutual fund vehicle and others that are looking for the CIT structure.

Remy Blaire: We touched upon active as well as passive. But when it comes to underlying management structures, what do you think is important?

Sarah O'Toole: We offer three different flavors of target date and active one that's invested in underlying managers that are all active or primarily active, a blended approach that's a mix of active and passive, and then a pure passive implementation. When we think about when to go active or passive, it really comes down to our view on that specific market segment. So, does that market have a breadth of opportunities that an active manager can take advantage of? Is there an efficiency that we can take advantage of from an informational perspective or does a team at Fidelity have an investment edge?

If we have an investment edge in a certain area of the market, we want to make sure that that investment edge is delivered to participants in our target date strategies. It's really an evaluation of those three things when we decide to go active or passive.

Remy Blaire: Susan, moving on over to you, when it comes to composition of structure, what should people be keeping in mind?

Susan Viston: Sure. We've talked a lot about glide path and the active and passive decision, but another critical decision is the use of underlying managers. There’re generally two schools of thought. The first is a closed architecture approach where the asset manager is sourcing underlying strategies internally only. Then there's the multi manager approach where there's a combination of both internal and external managers.

In our perspective, from Voya's perspective, we've always believed in having as much diversification and flexibility as possible. From day one of managing our target date funds, we have been multi manager, recognizing that it's very hard for one firm to manage every single asset class well.

But I think in the case of both closed or multi manager approaches, what's critical is to understand who is responsible for the manager selection process and what is their approach to due diligence selection and ongoing monitoring. From a fiduciary's perspective, how does that coincide with their manager research approach?

Remy Blaire: Susan, for viewers who might not be so familiar with some of these terms, can you elaborate on the closed versus the multi-manager?

Susan Viston: Sure. Again, when it comes to closed architecture, managers are only using the inhouse strategies that they have within their firm, while multi manager combines both inhouse managers where there is a strong capability with outside managers from across the industry to further diversify the portfolio.

There's a number of benefits to that type of structure. One, you're not beholding to the asset classes that a manager has inhouse. If we don't have emerging market equity fund or a debt fund, we're not restricted from adding that to our target date fund because we can use a manager from a different asset manager. Another benefit is being able to use different investment styles.

In many cases, in a firm, there's one investment philosophy when it comes to equities or fixed income. We, because of our multi manager approach, can invest in quantitative strategies, multifactor approaches, fundamental, and quantum mental type strategies. We do that not only to diversify our exposure, but to allocate between managers depending on the time to retirement. What I mean by that is as we get closer to retirement, we tend to focus on managers that can provide us better downside protection.

In our far data portfolios for participants who have a long time horizon, we'll tend to shift towards managers that can provide us that better upside capture ratio.

Remy Blaire: Well, Sarah, while we're talking about age, if someone is fast approaching retirement and they're taking a look at target date funds, but they feel limited because they only have a few more years left until retirement, are target date funds something that they shouldn't consider?

Sarah O'Toole: As someone is starting to save, no matter when that is, it can really help provide discipline to their asset allocation strategy. Saving into a portfolio that's diversified and professionally managed helps them towards their goals. There are variables that cannot be adjusted as someone moves toward their target retirement date. They may decide to work longer than typically age 65 to 67, which are common retirement dates.

They may choose to spend less in retirement. There’re variables in the participants that's in control of that can help them achieve their outcome. Generally, as someone approaches retirement, they have more information about their situation. They have a better idea of what they'll need in terms of spending and what other expenses they might have during retirement.

Remy Blaire: I'd like to move on to the topic of evolution of target date funds. The market does include various strategies that are considered active, passive or blend. Sarah, what rule can active management have in a target date solution?

Sarah O'Toole: It's a good question and a question we hear a lot in the market. I think with target date, it's really important to remember that all target date funds are active portfolios because that glide path decision, the strategic allocation decision, is an active one. We don't have an industry consensus or benchmark on what strategic allocation should be in a target date portfolio.

My first answer is that they're all active in some way. Then when it comes to implementation, that's where you get variations in a passive implementation, in active implementation or a blended implementation that has elements of both active and passive. One of the benefits of active oriented strategies is greater breadth in terms of what can be held in the portfolio.

Active strategies may have access to a broader number of asset classes or a broader number of securities if they're investing in underlying managers that are actively managing portfolios. They can also be more flexible. Target date portfolio managers that have that flexibility to move in and out of asset classes on a more intermediate term basis can provide more flexibility to investors in the strategies.

Remy Blaire: Susan, what is your take on active versus passive?

Susan Viston: Sure. I echo a lot of what Sarah said. I think there's been a lot of attention on active versus passive, maybe too much. I think it's important to remember that it's one factor to consider in a multitude of considerations when you're evaluating a target date manager and that the active passive decision is very different than in single asset class funds such as a large cap or core fixed income solution. It's for the reason that Sarah mentioned that there's no such thing as passive in target date. Even managers that are investing in passive underlying investments need to make active decisions. Those active decisions such as, "Should I have 60% equity for a participant who's right before retirement or 15%?" is going to have a much larger impact on retirement outcomes than the fee differential between active and passive managers in the space.

That being said, we think the act of the passive decision really lies with the plan sponsor in terms of their overarching philosophy and an examination of the pros and cons of each approach. For our perspective within Voya, we think the optimal approach isn't one or the other, but rather a blend of the two, where you can get a best of both worlds' approach in where you're only paying for active management, where the benefit outweighs the cost.

Remy Blaire: Now that I've gotten your perspective on this active versus passive, I want to move back to you, Sarah, and get your take on how you've seen strategies for target date funds evolve over the years.

Sarah O'Toole: I think over the years, target date strategies have really become institutional quality investment portfolios. Even though our end customers are retail oriented person in most cases, they've really become more sophisticated in terms of the tools that are used to manage target date funds. I think that's really brought the industry along quite a bit.

Another thing that we've seen in the marketplace is just evolution of product choice. Today, more types of products are available in terms of whether it's active, passive or blend, open architecture, closed architecture. There’re just more flavors of target date to meet different client needs. I think, looking forward, it's interesting because target date funds, they've been around for 25 years, but they're still in their infancy in many ways given where adoption is and where it's going. I think we'll continue to see more sophisticated tools, and implementation strategies, and asset classes included as we move forward.

Remy Blaire: Before I move away from you, could you elaborate on some of the different types of so-called flavors that are available right now?

Sarah O'Toole: Yeah. Active passive blend is one type of menu that clients typically evaluate. Really their choice depends on what their philosophy is with respect to the role of active in a portfolio or the role that fees have and how they think about constructing their plan.

Remy Blaire: Now, I'd like to move on to retirement risks. Now, accounting for roadblocks that could derail a secure retirement plan, we know that there are different types of risks like inflation or longevity as well as some behavioral risks. Susan, how should we think about risk factors at different stages in a participant's life cycle?

Susan Viston: Sure. Because target date funds were really designed to help an individual throughout their whole life cycle, there are many risks that they'll face and that a target date manager is trying to mitigate. But those risks will change in degree depending on where they are in their life cycle. Understanding a manager's approach those risks is a really critical aspect.

For instance, as individual heads into the critical 10 years before their retirement date, we would argue that the biggest risks they face is not longevity risk, but rather sequence of return risk, which is the day they retire is when they're most exposed to that risk than any other time in their life cycle, including when they are 10 years or 30 years away after retirement.

The reason for that is because their account balances are the largest, they're ever going to be and the day they retire, they have the longest period of time to fund their retirement without a steady paycheck. A significant market decline at that stage could impact their ability to meet their needs in retirement.

On the flip side, you have longevity risk, which is the risk of outliving your assets. We don't believe you need to solve that near retirement, but rather you need to do that in the mid and early stages of our participants' career by taking on more equity and risk in order to build account balances, build wealth over time, and do so when participants are less vulnerable to sequence of return risk because they have a long time horizon.

Remy Blaire: I think you mentioned some key points there. Sarah, can you give us more insight into some of the risk factors out there?

Sarah O'Toole: Yeah, when we hear the term risk used in the market, it's often associated with equity risk and market risk, but you really have to take a broader look at the overall risk that you're trying to manage for in a target date strategy.

Equity market risk is one risk, longevity risk, inflation risk is one that you also have to focus on because participants are seeking to replace real income in retirement, and they need an inflation protected asset to help them achieve that. Then behavioral risk too. We're really making a tradeoff and every provider's making a tradeoff among all of those risks.

For example, when we have equity exposure in the portfolio, we are in part solving for longevity risk and inflation risk, but we're also aware of the behavioral risk that a participant stops contributing to their target date fund because that's really a difficult problem to overcome. If somebody stops contributing, there's really not a saving solution that can get them to their goal.

We think about that a lot on the behavioral side and we've studied this over time what our target date fund investor's doing in their portfolio and they've exhibited very disciplined behavior and tend to stay the course even in very volatile market environment. That gives us another input into our process for calibrating risk in the portfolio.

Remy Blaire: I'd be interested to get a better understanding of some of these other behavioral risks. Could you shed a little bit of light on that as well?

Sarah O'Toole: Behavioral risk is really the risk that the participant abandons the strategy. We really carry that with us when we make our strategic allocation decisions. We spend a lot of time on the investment side of these portfolios. At their core, these are investment portfolios, but we always have to consider our investment ideas in the context of the participant, what are their sensitivities and what behaviors are they likely to exhibit given a specific asset allocation?

Remy Blaire: Now, I'd like to move on to the outlook for target date funds going forward. Susan, what do you think is next for target date funds in terms of innovation?

Susan Viston: Yes. I think innovation really depends on the life cycle. If you're talking about saving or you're talking about the spend-down phase? I believe in the saving phase given that we are in a global economic slowdown, returns for traditional asset classes are expected to be lower than they have been in the past.

I think you're going to see greater adoption of alternative and less traditional asset classes and strategies as a way to not only improve returns but offer diversification and lower correlation to traditional asset classes. Then when you think about the spend-down phase, I think that participants are going to need much more help now more than ever before given the dramatic changes that are taking place in the landscape, right?

We know the percentage of people that have access to a pension plan is less than they were 10 years ago. That's going to decline further from here. People are living longer. I think you're going to see much more innovation in the glide path during those critical spend-down phase to help participants, not only in terms of their investments, but also the right withdrawal strategy.

Remy Blaire: Would you like to learn as well?

Sarah O'Toole: Sure. I would echo some of those comments that the greatest need right now based on what we hear from the market is help with the withdrawal phase of someone's life. Participants will need tools and strategies to help them decumulate wealth and really live off that savings that they've accumulated. Much of the need today is actually among target date investors or people who haven't used target date strategies that are close to their target retirement date. We think that's really the next area of growth and innovation in target date type strategies.

Remy Blaire: Based on what you've observed, what would you say are the right ways to approach withdrawal?

Sarah O'Toole: I think having a disciplined investment strategy, so having an asset allocation strategy that's diversified, can change over time based on market views. Then having a withdrawal strategy paired with it that can adjust and provide income that's stable in retirement but also doesn't deplete the individual's assets at the end of their planning horizon.

Remy Blaire: Well, I think we've covered the foundation of this masterclass forge in describing what target date funds are and the application. Could we move on to misconceptions and talk about what we're seeing when it comes to the space? Sarah, why do people misunderstand target date strategies?

Sarah O'Toole: One of the things that I think is misunderstood in the target date universe is the role and the importance of strategic asset allocation and that it's not a commodity. To develop a glide path and a strategic allocation requires tremendous research, and insights, and a robust risk management process. We've kind of lost that as the markets move to really emphasize low fee and really have seen a lot in the market where a person looking at a target date fund thinks of them as all being the same.

Related to that, another misconception that we see in the market is that low fee equals safety from a fiduciary perspective. That really isn't the case. Choosing the cheapest available target date fund maybe a good thing for the participants. We won't know for many years, but it doesn't equate to meeting fiduciary obligations because as many people know, meeting that fiduciary obligation involves a really rigorous due diligence process.

Remy Blaire: Susan, would you like to dispel any myths that are out there when it comes to target date funds?

Susan Viston: Sure. I think a myth that is being dispelled in the marketplace today is that all target date funds are homogenous and that as a result, adequate due diligence process is to solely look at cost and performance. As Sarah mentioned, it really involves a much more detailed analysis, not only because of the differences in target date design and what that can mean to participant outcomes, but also whether this is a good fit for our participant population. We know that participant populations can differ quite significantly from each other. That's the benefit of having so much choice in the target date space today to pick the right one for your plan based on your participants' needs.

Remy Blaire: When it comes to retirement, we know the biggest risk is not contributing to your retirement. According to the Fed's latest report on the economic well-being of US households, it found that 26% of non-retirees have nothing saved for retirement. For that group, how would you address the question, what's the best way to choose the best target date fund?

Sarah O'Toole: I think the best step forward for those 26% would just be to begin saving. Then choosing the target date fund really comes down to looking at the target date fund that has the goal that aligns with your goal. I think that's where some alignment can come through. Obviously, the due diligence that many financial professionals are engaged in can help participants navigate that landscape because they're in the position to evaluate what the resources are, what the philosophy of the provider is, what the investment process is that will ultimately deliver the outcome that that participant needs.

Remy Blaire: What would you say to that in terms of choosing the best target date fund?

Susan Viston: I think from a participant perspective, the benefit of having a target date fund in a DC plan is that the only decision they need to make is, "When do I want to retire?" The target date fund will do the rest for them in terms of providing that broad diversification and adjust the risk level to be appropriate for your time to retirement. From an investment standpoint, it's a fairly simple decision for an individual.

Remy Blaire: I'm sure in your daily lives when you are talking to people about target date funds, you come across questions that are very common. Would you be able to share some of the common questions that you get asked about target date funds?

Sarah O'Toole: One of the questions we get quite frequently is, how have you chosen to diversify the portfolio away from equities? There's a lot of focus on equity allocation through time as a proxy for risk. We go a little bit deeper in our client conversations focusing on not only the broad asset classes we've selected but the sub asset classes we've selected. I think going through that process of how we've arrived at the strategic allocation gives plan sponsors or financial professionals better insight.

Remy Blaire: When it comes to target date funds and some common ways that investors may supposedly be misusing them, they might be investing in multiple target date funds or they don't stay invested long enough or people stop using target date funds and might make extreme changes to their asset allocation. What would be your feedback to some of that?

Sarah O'Toole: Yeah. We encourage target date participants to use one fund because we're managing towards that target retirement date. We generally see participants stay in the course. We don't see a lot of abandonment risk over the past 10, 20 years in these funds, which has been good. Most of the behavior in target date strategies, on the investor side, has been good, in my opinion.

Remy Blaire: As we head into the latter half of our masterclass, Susan, can you share your perspective on target date funds and some lessons learned within the space?

Susan Viston: Sure. A lot has changed in the target date space over the past decade. We've seen dramatic growth within target date. That's largely not only due to strong economic returns, but also just increased popularity among individuals as well as plan sponsors in terms of target dates being the default option of choice for many DC plans.

I think the lessons that we've learned is that having a well-diversified target date fund combined with auto features have served participants very well during the accumulation phase. I think what we can translate that into is a better approach to helping individuals during that spend-down phase. Not only from an auto feature standpoint, but also from a guidance and withdrawal standpoint to make it very easy to understand what withdrawal strategy is appropriate for an individual because we know there's not one solution that's optimal for all individuals and really help them meet their dual objective, which is not only to maintain their standard of living in retirement, but also to avoid running out of assets.

Remy Blaire: I'd also like to get your perspective and hear about some of the lessons you've learned.

Sarah O'Toole: Yeah. I think in the time that Fidelity has been managing target date strategies through many different types of market environments and also working with participants. Fidelity's been helping people save and spend for retirement for decades. Over 70 years, we've been working with people who are saving for retirement. We've learned a lot over that time, both about participants and about markets. We try to bring that to every investment decision that we make.

Remy Blaire: In a nutshell for investors as well as financial professionals, what are the key takeaways for them to remember when it comes to target date funds?

Sarah O'Toole: I think we all know that they've been extremely beneficial to people who are saving for retirement, but just a recognition that the due diligence process is very broad in scope. Understanding the people, and the resources, and the research that drives investment decision is really a core to understanding how that target date fund will behave over the short term and the long term. Approaching the target date evaluation process with that lens is really helpful in selecting one that's appropriate for a specific population.

Remy Blaire: Since I have both of you here, would I be able to hear more about the due diligence process that takes place at your respective organizations?

Sarah O'Toole: Sure. In a due diligence process, it's usually a long process in terms of many meetings over the course of perhaps a year, where a financial professional, whether it's a consultant or advisor or a plan sponsor is just getting comfortable with how we're managing the portfolios and really digging into the details. So, understanding the goal, the philosophy, and the process, and how we implement our ideas. Then, obviously, looking at performance as the output of that process and understanding what is performance, why has it been that way, what are the drivers? Really trying to understand if the performance profile we've delivered for our clients is aligned with what we've set out to do in terms of our process and philosophy.

Remy Blaire: What about you, Susan? What is the process over at Voya?

Susan Viston: Yeah. It's very similar. I think I'd add one other thing that trying to not only understand the objective and whether we've been able to meet that objective in different market environments, it's become much more important to be able to attribute the key drivers of investment decisions. How has the glide path added value within the target date perspective? How have asset allocation decisions not only from a strategic standpoint but also from a tactical standpoint?

Then finally, underlying managers. Have they performed the way you would expect them to in the market environment that we've lived in? I think having that attribution and tying it to your overall philosophy and objective has become increasingly part of the due diligence process.

Remy Blaire: As we round up this discussion on target date funds, what would you say are some of the challenges for the overall industry as we head into 2020?

Sarah O'Toole: A couple of things I would mention, which isn't really time dependent, but first just navigating a complex industry. Target date strategies can seem complex and they're all very different. That's one challenge that people face when they're doing their due diligence process. Then second, we've been through extraordinary times for the markets. Diversification over the past 10 years hasn't mattered too much. You didn't need to have too much diversification of outside of US equities, for example.

Going forward, we think that will change. As diversification becomes more important, there's likely to be more differentiation and performance across target date strategies.

Susan Viston: I would again agree with Sarah that I think the challenges and the opportunity today, then more so than in the past, is that the space has grown. We have now 65 off the shelf target date funds that are available to plan sponsors. We also have not only off the shelf, but customized solutions that may fit needs. Trying to navigate and put together a due diligence process for the various differences in a target date fund and tying that to a participant population and assessing best fit, I think will continue to be complex going forward even when you see the innovation in the space.

I think that documentation is going to be critical part of the due diligence process. Not only in terms of, how did you revive at that decision, but what is the process to regularly evaluate that in the future?

Remy Blaire: Now that we've covered the challenges as well as innovation, do you think there are any bright spots for this industry going forward?

Sarah O'Toole: I think the future is quite bright for target date funds. Even though we've talked about some of the opportunities and complexities today, I think there's a lot of opportunities as adoption continues to rise. These are the predominant savings' vehicle for most participants in a 401(k) plan. You have a lot of investment professionals digging into the research and the insights that will support these participants in retirement.

Susan Viston: Yes, I agree. I think when we look at participant behaviors in a 401(k) plan, a lot of times you'll see mixed use, where individual is allocating a portion to the target date fund and maybe to some of the standalone options. I think in some cases that is a benefit, right? Because they're doing so for a specific reason. In other cases, we've learned through surveys of individuals that one of the main reasons for mixing was because they wanted to diversify.

I think as education around the benefits of a target date fund that it was designed to be a well-diversified portfolio in and of itself will only increase adoption, and usage, and benefit not only individuals, but retirement savings.

Remy Blaire: Okay. Ladies, well, it's been a very comprehensive discussion on target date funds. Thank you so much for joining me and thank you so much for all of your insights.

Sarah O'Toole: Thank you.

Susan Viston: Thank you.

Remy Blaire: Thank you. Thank you for watching. I was joined by Sarah O'Toole, Institutional Portfolio Manager at Fidelity Investments, and Susan Viston, Client Portfolio Manager at Voya Investment Management. From our studios in New York city, I'm Remy Blaire for Asset TV.



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