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The Evolution of the Target Date Fund Selection Process

04.09.20

Are you sure you have the best target date funds (TDFs) on your plan’s investment menu? You should regularly review all of your plan’s investment options — especially when most participant deferrals are earmarked for TDFs.

Questions to Ask

In the early days of TDFs, the primary focus of performance and suitability review was on their glide paths: either the “to” or “through” glidepath models. In a “to” TDF, the fund’s asset allocation would become ultraconservative at the target date. In a “through” TDF, the glide path’s shift from balanced to no equity exposure occurs decades after the target date.

However, TDFs with similar glide paths can vary dramatically in their portfolio composition, risk exposure and performance. When examining a TDF series, focus on how a TDF management company makes decisions about its funds’ design to ask:

How do TDFs select asset managers to oversee investment selection of underlying funds? The TDF provider may use only in-house personnel, or it may tap best-in-breed managers from throughout the industry.

How do managers make the choices they have the authority to make? It’s common for TDFs to consist of a fund of funds, some with sub-funds that can be index-based. Be sure you’re clear on whether managers must adhere to a particular set of guidelines (and if so, what they are), or if they have free rein in their decision making.

What decisions have asset managers made? Broad similarities between TDF portfolios can mask important differences on closer examination. Look at the asset category breakdown at the subcategory level. For example, within domestic equities, determine the mix of growth, value and small cap stock sectors. For international equities, examine the split between emerging market and developed country corporate stocks.

How aggressive is the underlying investment strategy? This looks beyond the basic “to” or “through” framework. Side-by-side comparisons of TDFs having the same general glidepath philosophy will often reveal substantial differences in the timing of the transition between an equities-dominated asset mix to fixed income.

Such variations may reflect varying levels of emphasis on participants’ risk of outliving their assets, and their risk of underfunding their retirement portfolios. A more aggressive investment posture heading toward the finish line (whether that’s retirement or life expectancy) before the downshift to a more conservative posture indicates a focus on underfunding risk.

Ask the Right Questions

As TDF assets have grown, so too has the sophistication of quality and suitability analysis for a given workforce. Make sure your plan advisors are up to the task. Your outside advisors can assist you with the process.