Another important consideration, according to Gascho, is what constitutes an appropriate glide path. He notes that various funds will have different ratios of equity to fixed income, which makes comparing funds difficult. And since each TDF’s structure is unique, there is no external benchmark. For this reason, Gascho adds that those offering TDFs need an investment consultant to help them construct an appropriate fund benchmark.
In the wake of the recession and its consequences, the composition of TDFs has also been questioned. Jean-Daniel Côté, Mercer Canada’s DC retirement consulting leader, believes that one challenge with TDFs is that they are “black boxy,” meaning investors don’t know what their TDFs hold. “It’s impossible to tell the difference between one target date fund family and another,” he says, adding that funds’ names should be more meaningful to plan members. Questions have to be asked, adds David O’Leary, manager of fund analysis for Morningstar, about what qualifies as a TDF and what makes for a quality product.
For all of these reasons, due diligence is an important part of implementing this investment option. Benchmarks must be weighed, and the layering of fees must be considered, according to Gascho. He notes that it’s important for administrators to ensure that any decisions regarding the choice of TDF will be “defensible if the administrator is later challenged,” cautioning that “TDFs are potentially very powerful” but that an administrator must tread carefully when working with them.
The TDF of the future
Diversification, sophistication, and customization are all upcoming trends for TDFs. Since some Canadians are working past their traditional retirement dates, Côté observes that plan sponsors may choose to fine-tune their funds by setting the default target date around, say, the member’s 70th birthday. The asset mix of TDFs may also change as a result—Côté notes that TDFs may invest longer in equities, for instance.
Furthermore, as the TDF market grows and develops, Farley foresees a “broadening out” of TDF asset mixes, and Côté believes that there will be more alternative investments, such as infrastructure or hedge funds, involved. Outside of the investment lineup, Loder believes that Canadian TDFs should—and will—become more sophisticated, including enhancements such as inflation linkages, contemplation of a guaranteed income stream post-retirement and glide paths that continue past employee retirement dates.
Customization is another important TDF trend. “As assets in TDFs grow, there will necessarily be more customized analysis of both glide paths and performance,” Choi suggests. And Côté believes that one-size-fits-all TDFs will be challenged by customized TDFs in which plan sponsors will pick the managers, the various asset classes and the glide path.
However, greater customization brings with it increased responsibility, time and resource commitments. Most plan sponsors, Côté admits, may say this is too much work and added risk, preferring instead to use an off-the-shelf product.
Given the overall lack of transparency around TDFs, industry experts also foresee greater investor education on the available options and strategies. Farley says investors need to understand the difference between, for example, Manager A and Manager B, as well as active versus passive management of TDFs. Loder and Choi add that with TDFs, there should be more education at the front and back end—retirement income goal-setting and contribution rates during the accumulation phase, with education and communications customized to each particular investor type.
Finally, when it comes to costs, Farley suggests that in the future, TDFs will be more affordable. “Most sponsors recognize that fees should be reasonable,” Côté agrees, adding that the differences between an external versus in-house manager for a provider can affect costs.
Each investment product or strategy will respond differently to economic and market conditions, so it stands to reason that each must be carefully considered for its effectiveness at different times during the investor’s lifetime. But whatever challenges TDFs may pose, it’s likely that they will continue to play a role in many investors’ long-term investment strategies. BC
J. Lynn Fraser is an author and freelance writer in Toronto.
> click here for a PDF version of this article
© Copyright 2010 Rogers Publishing Ltd. This article first appeared in the May 2010 edition of BENEFITS CANADA magazine.