In evaluating which funds to choose, plan sponsors and investment managers usually consider the three Ps: performance, process and people. These aspects are of the utmost importance when it comes to target date funds (TDFs). Unfortunately, the first of the three Ps—performance—presents some challenges.
One such challenge is conducting an apples-to-apples comparison of TDFs. “Comparing the performance of Company A’s 2020 fund and Company B’s 2020 fund, for example, is not a fair comparison if they have differing levels of equity,” says Peter Chiappinelli, senior vice-president, investment strategy and asset allocation, with Pyramis Global Advisors. “In up markets, the more equity there is, the better the fund [performs]. In down markets, the opposite is true. But that doesn’t make one fund ‘better’ than the other.”
With this imbalanced comparison, then, plan sponsors have to look more at the process and the people, and then make a judgment on which TDF is suitable for their employee populations.
Considering process and people may seem to be a more subjective approach, but Chiappinelli isn’t quick to judge. “I hesitate to call these subjective because then people want to dismiss it as unscientific,” he says. “There are scientific ways to do it. And we have lots of opinions about what makes for a good process, a good team and a good portfolio construction methodology.”
When determining which TDF is suitable for a particular employee population, plan sponsors should ask the following questions of their prospective investment firm and manager.
Key questions to ask
• Is the glide path well conceived? Has it been tested in various market cycles?
• Are the glide path’s objectives well defined? How is success defined? By income replacement ratio? Dollar amount? A sustainable withdrawal objective?
• Have the models and assumptions been stress-tested?
• Does the model make realistic assumptions about participant behaviour, or does it ignore participant behaviour and data altogether?
• Does the investment manager use modern portfolio construction tools, such as stochastic modelling, that are more relevant to defined contribution plans (versus defined benefit plans)?
• What kinds of risks are monitored and managed? How does the glide path manage longevity risk? Tail risk? Sequence risk?
• Is the product too reliant on a single manager for a specific asset class? Is there a backup?
• Does the allocation include extended asset classes such as high yield, real estate investment trusts?
• What is the process for monitoring and/or replacing underlying building blocks?
• Are the underlying blocks institutional products or retail mutual funds?
• What is the background and experience of the team as it relates to TDFs?
• What skill sets are represented? Asset allocation? Portfolio management? Risk management? Actuarial capabilities? Capital markets forecasting? Manager selection? Quantitative modelling?
• Is this a dedicated team or a part-time endeavour for a few portfolio managers?
• What is the commitment of the organization to TDFs? What are the organization’s current assets under management?
• What other values does the organization bring to TDFs? What research is the firm doing on retirement issues in Canada?
Brooke Smith is Associate Editor of Benefits Canada.