Exploring the active nature of target-date funds

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Technical price graph and indicator, red and green candlestick chart on blue theme screen, market volatility, up and down trend. Stock trading background. © Dima Zahar / 123RF Stock PhotosLooks aren’t a solid basis on which to form a long-term relationship and neither is the surface-level appearance of a target-date fund.

“In a perfect world, we would like our members to have a long-term relationship with a target-date fund we’re offering,” said Zaheed Jiwani, a principal at Eckler Ltd., at Benefits Canada‘s 2019 Benefits and Pension Summit on April 17. “Think about it: till death do us part.”

TDFs are the most sophisticated investment option for the defined contribution pension market, but they can appear deceptively simple if plan sponsors don’t dig down into their different methodologies, he said.

Due to the large number of plan sponsors using TDFs, and especially for those using it as the default option, it’s critically important employers understand exactly why a specific fund is ideal for a given member population, noted Jiwani. While TDFs are designed for members to understand their basic principles, underneath they’re anything but simple, so plan sponsors have to come to grips with their various components to ensure they’re choosing the best option for members.

When picking an investment strategy, asset allocation is widely argued to be the most important factor, he said. “No matter who you talk to in the investment industry, they can all hinge on this statement: asset allocation . . . is going to be the single biggest driver of the variability of returns and even of returns themselves.”

One example for the Canadian market is how equity managers performed during the 2008 financial crisis. Looking broadly at Canadian equity managers, there was minimal difference between the best and worst performers during that market event. “It didn’t matter which Canadian equity manager you had, what mattered was how much Canadian equity you had,” said Jiwani.

Within TDFs, asset allocation has increased importance, he added, noting the equity component varies dramatically in the Canadian market in looking at the different vintages of the funds. “Depending on which glide path, which target-date suite you’re in, you have a very different allocation just to equities versus bonds. Once you start splitting the pie up and looking at the different sub asset classes, it gets even more different.”

With the heightened importance of asset allocation, plan sponsors shouldn’t think of TDFs as a passive vehicle, said Jiwani. “There is no such thing as a passive glide path. We hear, ‘Oh, I have a passive target-date fund.’ It’s not true. The underlying components are passive, but the glide path was an active decision by an investment manager.”

Plan sponsors have to go deeper on the glide path, he stressed, noting the extent of their exploration is often looking at how the equity component rolls down over the years. “You need to understand not what the glide path looks like, but how it was built.”

The investment industry uses a wide variety of methodologies to put glide paths together, so plan sponsors must be careful not to assume one is like another, said Jiwani. They should look at these strategies first, before diving into the underlying funds making up the vehicle, he added.

While the asset mix will change over time with any glide path, two key issues to consider are how a particular TDF models for time in relation to risk and what asset classes it includes in the mix at any given time, he said.

This article originally appeared on CIR’s companion site, Benefitscanada.com. Read the full story here.

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