Session 3 – What’s the Take on TDFs After the Mother of All Stress Tests?
Why it’s important to know how to evaluate target date funds.
By Mark Friebel, Senior Vice-president, Head of Global Investment Strategies, Pyramis Global Investors
From their roots in the 1970s, TDFs or lifecycle funds have grown into sophisticated global offerings that encompass a wide range of asset classes in search of alpha and beta diversification.
TDFs have also become an integral part of the U.S. pension fund landscape. Pension fund losses in the post-2000 bear market boosted TDF popularity, as did the growing shift from DB to DC plans. Managers who are considering new strategies to gradually rebalance assets and ensure the funding of plan participants’ long-term retirement needs have increasingly adopted the TDF model as a default option.
In Canada, growth isn’t quite as advanced, with an overall market of about $6 billion. However, interest continues to grow among the largest Canadian plans. The landscape is dominated principally by mutual funds, although roughly one-third of TDF assets are managed as pooled funds.
Importantly, TDFs are assuming the features of DB plans, using strategies ranging from 130/30 to market neutral as they seek alpha and beta diversification. Derivatives may soon be in the mix as well.
Given these changes, it’s important to dispel the myths about TDFs—including the notion that they are inappropriate for sophisticated investors—and understand how best to evaluate them.
Know Your TDF
Assessment of a TDF boils down to three key factors: the firm, the portfolio management team and the construction of the fund’s portfolio.
A TDF is, by definition, a long-term investment—as long as 40 years—so it’s important to conduct proper due diligence on the firm managing it. Such firms should be large, with considerable diverse assets under management. The firm should also have a large, diverse client base and a reputation as an innovator, helping clients develop solutions to assure their futures.
A TDF’s portfolio management team should be seasoned by exposure to several market cycles. This implies a deep understanding of how markets work, as well as familiarity with investment consulting, actuarial science and possibly academic work. The ideal is a manager who can merge factual and theoretical knowledge to build an effective portfolio.
Portfolio construction, the third essential pillar of a successful TDF, is often model-based. It should make sense to investors, and there should be a visible resemblance between the model and the portfolio itself. It should also be innovative, incorporating new ideas from the investment industry and from academia.
Performance: What to Expect
How do these suites of funds perform? Scenario analysis done from a total return perspective indicates that longer-dated funds—those with more equity content—act more like equity markets, while shorter-dated funds with more fixed income content behave like the fixed income market. As for adequacy of retirement income, scenarios worked out over different 20-year retirement periods indicate that TDFs provide more than sufficient funds.
Still, TDFs are constantly evolving. With the rising emphasis on the DC marketplace, it’s likely that TDFs will increasingly adopt the features of DB plans going forward. BC
Continued on the next page…
Session 4 – The Importance of Global Equities in DC Plans
Global equities offer diversification and growth opportunities for Canadian investors.
