The past few years have seen considerable product development initiatives aimed at helping capital accumulation plan (CAP) sponsors choose appropriate investment vehicles to offer their members. After years of struggling with the educational and engagement challenges of getting members appropriately invested, the allure of target date funds (TDFs) and related products has been a siren call too strong for many sponsors to ignore. There has also been increased interest in principal guarantees on balanced portfolios.
U.S. 401(k) trends have provided Canadian plan sponsors with a certain level of comfort in introducing TDFs into their lineups. In some instances, such products now form the default option for disengaged members or those unable to make their own investment decisions.
Combatting Member Inaction
No one underestimates the difficulty that plan sponsors face in getting members to participate in the investment process. But while TDFs may play a role in resolving this issue, there will always be retirement planning decisions that a member must make, such as selecting a personalized time horizon and risk tolerance, as well as determining options upon retirement. In this context, TDFs do not solve all of the challenges associated with CAPs; they simply defer them to a later time.
A plan sponsor’s duty is to ensure that members take control of their own investment decisions, yet the messaging around TDFs is, “make this choice, then do nothing until retirement.” Perversely, the use of TDFs could actually encourage inertia rather than break through the stubborn cycle of member inaction.
TDFs do solve the problem of getting members into well-diversified portfolios. They also take the next step of trying to tailor the asset mix to a member’s requirements, based primarily on age. However, there are other approaches that achieve similar results, such as pre-assigned mix portfolios and asset allocation funds, which also offer a level of customization that may prevent potential issues down the road.
Meeting Members’ Needs
It’s important to remember that age is but one dimension in understanding what type of portfolio to use. Factors such as the member’s risk tolerance, other sources of retirement income and savings rates also influence the type of asset allocation that a plan member may choose.
Each TDF implements a different asset allocation path from inception through to retirement, often referred to as the glide path. However, when looking at the glide path, there are a number of important considerations. Is the glide path for a specific product the right one? Does it gel with the member’s particular circumstances? What will be the underlying capital market experience during the life of the glide path? These questions lead to the idea of glide path risk. Assuming that age dictates all is an oversimplification that may create a false sense of security for both the plan member and the sponsor.
Managing Liability
By design, CAPs are meant to transfer 100% of the investment risk to the plan member. Plan sponsors are responsible for making sure that the CAP is governed appropriately. However, they are not responsible for the investment outcomes of the products in members’ portfolios, though they are responsible for making sure that the investment options offered are appropriate.
This is where TDFs pose a certain challenge. Given that every product has its own twist in charting the path to retirement, there will be a divergence in how different TDFs perform over time. Some of this divergence will come from the actual management of the equity and fixed income portions of the portfolio but, arguably, the largest percentage of the divergence will be due to the glide path selected by the plan sponsor.