Defined Contribution Insights
In its 2013 guidance on target date funds, the U.S. Department of Labor stressed the importance of thoroughly understanding a series’ asset allocation, fees and results. Yet evaluating target date funds can be complex given the diversity of offerings in the marketplace. An online tool, Target Date ProView℠, aims to make that process easier by providing insightful, objective data to compare target date series. In this video, Capital Group investment specialist Rich Lang and portfolio manager Wesley Phoa outline key criteria for evaluating target date funds and explain how Target Date ProView can help. Learn about:
Craig Duglin: Wesley, Rich. Thanks so much for joining us today. What was the catalyst to creating the ProView evaluation tool? What is the tool, and what exactly does it do?
Rich Lang: So it’s really aligned with the Department of Labor tips, which came out in 2013 and it helps advisors establish a process and document a process in creating and evaluating a target date series. They can select any target date series they want to evaluate, and then the simplicity. Within four or five clicks, they can generate a report. After 30 seconds, they can compare four different target date series and have that output available.
Craig Duglin: How does the tool help plan sponsors with their selection and monitoring responsibilities per the DOL guidelines?
Rich Lang: The tool really highlights four criteria that the DOL calls out in their tips: glide path, risk, return and expenses, and highlight that so they can get a better understanding of how those different criteria compare for different target date fund providers and then they can establish that process, use that information to kind of monitor and document how they compare.
Craig Duglin: Rich, there are several target date evaluation tools in the market. What really differentiates ProView from the others?
Rich Lang: I think what really stands out is the simplicity and the objectivity of our tool. We aligned it with the DOL tips, it’s all Morningstar data, they don’t have to select our series as part of the evaluation. They can select any target date series to do that evaluation.
Craig Duglin: So, what should target date evaluation be focused on? Glide path, underlying funds? What are the most important characteristics to examine?
Wesley Phoa: For a target date fund to do its job, everything has to be working well. The glide path has to be designed properly to make sure that it meets the changing needs of plan participants as they move through their lives. But also, the building blocks that go into the glide path have to be excellent. They have to deliver superior results and behave in a way that is predictable and delivers the objectives that are required at each stage.
Craig Duglin: Rich, what would you add?
Rich Lang: I think when you're evaluating a target date fund, you really have these competing risks. You have market risks, and longevity risk that may be different from other funds you may be evaluating. So, I think having a better understanding of how those risks trade off at various points in the glide path is important. So, I think both the building blocks that are used to address those risks and the glide path are important to understand.
Craig Duglin: Wesley, what data points or metrics within the tool would you highlight as most distinguishable from the other tools in the marketplace?
Wesley Phoa: One of the things that’s very important to understand about the glide path and how it behaves for different investors is what we call the capture ratios. How much you participate in the market when it goes up and down. For a relatively young plan participant, the important thing for them is when market returns are strong, they fully participate in that. That’s why we look at the upside capture ratio. For a plan participant who’s older, approaching or in retirement, the important thing for them is that if you get a significant market decline, they’re somewhat protected from that. And it’s the downside capture ratio that helps measure that.
Craig Duglin: How do you think about the multiple dimensions of target date analysis?
Wesley Phoa: That traditional view, which shows the equity bond mix, is a great overview, very high level overview of what’s happening in a glide path. But we know that different providers can look quite similar based on that traditional view, and yet, the target date series they deliver behave in very different ways. For example, a growth equity might make a lot of sense for a 30-or 35-year old to own. It may make less sense for someone who’s 60 [years old]. You need a tool that can do an x-ray into the equity allocation and see if that line of thinking is really reflected in the way the glide path is built.
Rich Lang: I would just say that’s probably the biggest differentiator. When we go out and meet with advisors and show them the output of the tool and show that equity glide path volatility. Think that’s the thing that sticks out the most and they look at those numbers and they see certain providers where they don’t change the types of equity or the volatility of their equity throughout the glide path. And they look at that, because they know when they construct portfolios for their clients they do change the types of equities for their 25-year-old participants versus their 65-year-old participants. And it’s kind of that "a-ha" moment you get with advisors when they see that kind of equity glide path volatility look through.
Craig Duglin: Wesley, is a decomposition of these more nuanced aspects of a target date series particularly important at transition or in distribution?
Wesley Phoa: When a plan participant retires, some things change and some things stay the same. What changes is the nature of the risk that they face. When you’re in your savings, your accumulation phase, you can observe a market downturn, you know that you have some opportunity to see market prices recover. When you’re retired and taking distributions, that changes. You have what’s called a sequence of returns risk. A market downturn today has a much more adverse impact on you than one that occurs later. Because you’re taking withdrawals and you cannot make up any market losses on the money that you’ve already withdrawn.
What stays the same when you retire is that you’re still a long-term investor. You still have a couple of decades, maybe more, of life ahead of you, and an uncertain lifespan. So, your investments need to be generating sufficient return to address that longevity risk. And an important aspect of evaluating any glide path post-retirement is seeing how it addresses the trade-off between managing that sequence of returns risk, the adverse impact of early losses in retirement, against the need to generate sufficient returns so that your savings will last for the full period of your retirement.
Craig Duglin: So Rich, we’ve talked a little bit about the difference between our traditional view and our deeper view. Any particular metrics you would highlight within the deeper view?
Rich Lang: I think evaluating risk is important, really in any investment, but particularly a target date series. And understanding what the different types of risk are. Your traditional view is, you look at standard deviation and Sharpe ratios to understand, how a series has done on a volatility basis and then Sharpe ratio is on a risk-adjusted basis. But there’s going to be points in time where Sharpe ratio might not be as impactful. There could be a point in time where equities struggle, and those target date series that have the best Sharpe ratio are those more fixed income heavy target date series that may not be addressing longevity risk as much as some participants may need. I think just the overall capture ratio may be a more enduring metric for comparison, particularly if equities struggle to compare both market risk and longevity risk and which target date series best address those two risks.
Craig Duglin: So Rich the tool was launched about a year ago. You’ve been in the marketplace with lots of advisors and consultants and plan sponsors. How have you seen the tool being used? What best practices have emerged?
Rich Lang: We’ve really seen the tool being used at really all stages of the sales process. So the initial evaluation part of the process, where you’re beginning to look at maybe four or five different target date fund providers. We’ve seen it being used in a finals presentation, going to present to the committee using the output from ProView in front of a committee. Then once they’ve selected their target date series, we’ve seen it in the monitoring and evaluating process that a committee or an advisor will use and that really helps them in documenting that process. Then year after year, as they do those reviews, they can continue to rely on the ProView tool to help with that process.
Craig Duglin: Thanks for joining us.
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