Tuesday, August 23, 2016

Guidelines for Reviewing Target Date Funds

The U.S. Department of Labor’s Employee Benefits Security Administration issued tips intended to help plan sponsors select and monitor target date funds (TDFs) in their investment lineups. It is incumbent on plan fiduciaries to establish a process or fiduciary best practice for comparing and selecting target date strategies, especially when they serve as the plan’s Qualified Default Investment Alternative (QDIA). Fiduciaries should implement a process to perform periodic reviews to have a clear understanding of the investments and how they will change over time, and to compare the funds’ fees.

Target date funds automatically adjust their asset mixes to become more conservative as investors approach retirement age. This shift in the asset allocation over time is called the TDF’s glide path. Some TDFs’ glide paths are managed “to” retirement, while others are managed “through” retirement.
Risk Level at Retirement
Comparison of 
to versus through funds
© 2015 Morningstar, Inc. All Rights Reserved.

A “to” approach reduces the equity exposure over time to its most conservative point at the target date. A “through” approach continues to manage the asset allocation beyond the target date and will eventually reach its “landing point,” or most conservative allocation, years later. According to the 2016 Target-Date Fund Landscape Report from Morningstar, Inc., a leading investment analysis firm, as of December 2015, of the 60 available target date fund series, 23 were “to” and 37 were “through.” It is also worth noting that T. Rowe Price, Vanguard, and Fidelity Investments all manage a “through” glide path and accounted for 70% of the industry’s target date fund assets as of December 2015.

Another consideration is whether the underlying funds utilize active management or follow a passive strategy. Passive funds will have lower expense ratios than active, but may lag in tactical flexibility. Active strategies may provide increased breadth of choice in the asset classes that are offered and a broader choice of non‐traditional asset classes, such as commodities and real estate investment trusts (REITs). Non-traditional asset classes might not be appropriate as stand‐alone options in a participant‐directed defined contribution plan; an active TDF portfolio manager can better allocate assets among these non‐traditional asset classes and capitalize on tactical tilts.

Some firms such as T. Rowe Price include a blend of both active and passive underlying funds. All target date funds employ an active approach in the construction of their asset allocation glide paths. Overall, TDFs should be dynamic and flexible enough to change as market conditions vary.

Read 4 Steps to Building an Optimal Retirement Plan Lineup for Participants and download the Fiduciary Checklist for Target Date Fund Decisions to learn more. If you have any questions, or would like to begin talking to a retirement plan advisor, please get in touch by calling (855) 882-9177 or e-mail us at sbs@hanys.org.

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