Canadian Investment Review

The Trouble With TDFs: More Conceptual Hurdles

Written by Gerry Wahl on Tuesday, February 8th, 2011 at 8:45 am

156597_fence_1Following on last week’s post, I’ve included some additional conceptual hurdles that plan sponsors need to be comfortable with before introducing target-date funds (TDFs) into their plans:

Benchmarking

Benchmarking is an important part of pension governance and it’s an area of concern with TDFs. There does not appear to be consensus on the best way to benchmark TDFs. A common approach is to create a market-related benchmark for each fund within a TDF family based on the weighted average composite equity and fixed income indices. However, this requires assumptions about the future asset mix and the availability of appropriate benchmarks for all equity styles.

Questions for plan sponsors to ask here are what is the appropriate benchmark for each TDF fund or stage of the TDF? And are indices used to constructing each fund readily available to allow a benchmark to be constructed?

Given the nature of and purpose of the TDFs and the fact that they are often used as the capital accumulation plan (CAP) default fund, an absolute return benchmark may be appropriate or perhaps CPI plus, say, 4% as is often used in defined benefit (DB) plans.

Fee Structure The fees and costs paid by a CAP member have a significant impact on their asset accumulation over time. Because of this, plan sponsors need to consider the following:

Given that asset mix changes over time, fees should also decrease (e.g. more fixed income and/or the use of passive managers should result in lower fees).

Once you have selected the TDF supplier, you are locked in with respect to fees. The amount paid increase automatically as contributions are received and the market values increase which is very advantageous to the TDF provider.

Peer group comparisons – Peer group comparisons of TDFs are not readily available in Canada because of the limited number of providers and differences between TDFs. TDF families can be quite different with regard to things like passive vs. active, the philosophy regarding glide paths, and retirement dates. These differences make it difficult to compare TDFs.

Transparency and Conflict of Interest– A TDF family may utilize other pooled funds managed by the providers or an associated organization. If a TDF provider is using primarily its own funds and, the TDFs are not performing appropriately it raises a number of fiduciaries issues. Plan sponsors should consider the following:

Regulation

Regulation of TDFs is still in an evolutionary phase in Canada and the US, which leaves plan sponsors with a limited regulatory framework. An article in the Financial Times (July 2009) reported that “(US) Fund managers are working hard to convince regulators to keep their hands off target date funds”. The article also goes on to state, “the majority of fund manager company representatives testifying said regulating target date funds would stifle innovation.”

Now, think back a few years to when this type of situation existed before….

In my next post the advantges and disadvantges of TDfs will be reviewed.

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