For many plan sponsors, getting capital accumulation plan members to save for retirement is a challenge. There are risks to consider: undersavings, market, mortality, longevity and inflation, says Rod Bare, director, asset allocation strategies, Morningstar Indexes, with Morningstar, Inc. “It’s within that context that target date funds have been forged, and they’ve had various degrees of success at mitigating all those risks.”

A target date fund (TDF) assumes an asset allocation that begins with aggressive investments (equities) and gradually shifts toward more conservative ones (fixed income) as the member moves closer to retirement (the target date). This is known as the glide path.

Unfortunately, it’s this dynamic asset allocation that makes the TDF challenging to benchmark. While it’s generally accepted that the S&P/TSX is a standard benchmark for measuring Canadian equities, there is no one standard for TDFs. “[The S&P/TSX] is an investable index. It’s transparent [and] has all the attributes of a good benchmark,” says Peter Chiappinelli, senior vice-president, investment strategy and asset allocation, with Pyramis Global Advisors, a Fidelity Investments Company. (See “A Good Benchmark Should Be…” on page 39.)

“TDFs are not all created equal,” says Oma Sharma, national partner with Mercer. “You can’t assume that two TDFs maturing in 2020 are going to be similar across two different managers because there are significant differences in the way these products are constructed.”

How, then, do plan sponsors know if their TDFs are doing what they’re supposed to do? While there are a few strategies for measuring the short-term performance of TDFs, none of them are perfect, and context must be carefully considered.

Measuring Up
Peer group comparisons are one type of TDF benchmarking. A number of U.S.-based consulting firms use the TDFs in their databases to create a peer group comparison for each TDF by date—for example, comparing all of the 2040 funds across all investment managers. But this apples-to-apples comparison is limiting. “The aggressiveness of the glide path of each individual TDF will have a huge impact on how a manager fares relative to their peers,” says Colin Ripsman, vice-president with Phillips, Hager & North Investment Management Ltd. A recent case in point: those managers with TDFs that had higher exposure to equities in 2008 did not perform as well as those funds with lower equity exposure.

Published indexes are another alternative. There are no published indexes in Canada at present, but the U.S. has a few that appear to be vying for accepted industry status. Dow Jones introduced its target date indexes in 2005; since then, Target Date Analytics and Standard & Poor’s (S&P) have followed.

However, as Chiappinelli explains, these indexes are not ideal. “The ones that are out there would fall short on many of the criteria [of a good benchmark],” he says. For example, there’s no transparency around why some asset classes (such as commodities and high yield) are or aren’t included and why.

Since published indexes and peer universes are not the most accurate performance measures, most investment managers provide a custom benchmark for their TDFs. This customized benchmark is a weighted average of all of a TDF’s underlying funds.

While this is a useful metric, plan sponsors need to realize it’s measuring only the underlying funds, says Chiappinelli. For example, he adds, if Fund A from Company X is beating its benchmark over a certain time frame, that means the underlying funds are doing their job. It doesn’t say whether Fund A from Company X is better than Fund A from Company Y.

The CFA Institute says a good
benchmark should be…

• representative of the asset
class or mandate;
• investable;
• constructed in a disciplined
and objective manner;
• prepared with publicly
available information;
• acceptable as the neutral position by the manager; and
• consistent with the underlying investor status (e.g., regarding tax bracket, time horizon, etc.).

Go Long
While the focus today is still on benchmarking the short-term performance of TDFs, Vanguard Investment Consulting & Research has proposed two “goals-based benchmarks.” The first benchmark gauges the return needed by the typical investor to have sufficient funds at retirement. The second considers fund performance relative to the manager’s long-term product return expectations. In other words, if the TDF is designed to deliver X% of an employee’s final pay, the fund needs to deliver, say, a 6% or 7% return over a 40-year period, says Ripsman.