Hands on

Another problem with most TDFs is that they assume that every investor has the same risk profile—but that’s not true, argues Greg Hurst, a principal with Morneau Sobeco. Benchmarking also proves complicated, as no two TDFs are the same.

Target risk fund
Closely related to the TDF is the target risk fund. A target risk fund not only considers the length of time to retirement; it also considers the employee’s own risk preferences. This is important because two 40-year-olds may have completely different risk profiles: one may be conservative; the other, aggressive.
“In an ideal world, it might be useful to be able to use a target risk fund because that would take into account not just when the employee is retiring but what the employee says about his own views and beliefs in risk,” says Parchment.

But the challenge with a target risk product is that it requires some level of employee engagement, as the employee must complete a risk profile. “You have to get the employee to be engaged enough to fill in a questionnaire—and that’s probably not an employee who’s defaulting,” says Parchment.

The right combination
Some say the best of both worlds is a combination of the TDF and the target risk fund. Combine a target risk fund (with anywhere from three to five risk profiles: conservative through to aggressive) with the TDFs to cover the retirement dates within the plan sponsor’s employee base (generally about seven funds to cover a 30-odd-year span). That could be as many as 35 (seven times five) different asset allocations. “It’s very expensive to manufacture,” says Hurst. “But the key is, there are some organizations’ recordkeeping systems that manage portfolio allocations.” In other words, the 35 different asset allocations are maintained as individual member portfolios of traditional funds on the recordkeeping system that are periodically rebalanced to match a lifecycle glide path together with the individual’s risk profile. This solves the benchmarking issue by permitting benchmarking on the underlying funds using traditional methods.

Plan sponsors need to ensure that the default meets the needs of their plan members. But no matter which investment option a plan sponsor chooses, it won’t make a significant difference unless plan members are saving enough. A study done in March 2010 by the C.D. Howe Institute estimates that most Canadians, if they want to retire at 65 and replace 70% of their working incomes, will have to save from 10% to 21% of their pre-tax earnings every year for 35 years. “We’re not alchemists,” says Friebel. “We’re not going to make gold out of lead.” BC

Brooke Smith is managing editor of Benefits Canada.
brooke.smith@rci.rogers.com

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© Copyright 2010 Rogers Publishing Ltd. This article first appeared in the May 2010 edition of BENEFITS CANADA magazine.