My previous article, Finding the target (date fund), introduced target date funds (TDFs)—also known as lifecycle or age-based funds—and provided background for why they are becoming an increasingly popular choice for capital accumulation plan (CAP) sponsors and their plan members.

TDF usage by members will often be very high, and plan sponsors should ensure that the TDF family they’re offering is appropriate for their membership. This is especially important as new products are launched, many with new, key differentiating features. As discussed in detail in Part 1, the TDF’s glide path, or asset mix through time, will be a key differentiator between products, but plan sponsors should also evaluate many other aspects as part of the due diligence process.

Glide path implementation

Not only is the point-of-time and through-time asset mix important but also the evaluation of other aspects of how the glide path is implemented. Plan sponsors, then, need to consider the following questions:

  • Is the glide path managed to the retirement date or through the retirement date?
  • Does the fund use active or passive management, or a mix of both where optimal?
  • Does the fund employ “best-of-breed” specialty investment management, or can one manager deliver the required performance in all asset classes?
  • Is there a tactical asset mix overlay to the glide path (i.e., does it try to add value over time)?
  • Will the asset mix and fund composition evolve over time and who will make these decisions?
  • Does the fund family offer multiple risk tracks (i.e., conservative, moderate and aggressive) versus the one-size-fits-all approach?
  • Can you tweak the asset mix later in the life of the fund, based on the plan member’s financial situation?
  • Does the retirement fund include a real return component?

Product asset classes
Many of the first fund families used only the basic asset classes—cash, bonds and domestic and foreign equities. As more products have come to the Canadian market, providers continue to expand the types and flavours of asset classes in their products. Examples include LDI-oriented bond allocations, low volatility equities and alternative asset classes. When evaluating a fund, then, plan sponsors should explore the following:

  • What asset classes are offered? Do these assets provide adequate diversification?
  • Do you use, or are you comfortable with offering, alternative investments?
  • Are the asset classes liquid? What are the possible implications if they are not?
  • How do you manage your fixed income exposure? Does it make sense for your members?
  • Do your equity asset classes have a strong style bias (value/growth), and is this consistent with your plan philosophy?
  • What is your foreign equity exposure, and is it appropriate?
  • How do you handle currency hedging, if you handle it at all?

TDF performance
Over the long term, TDF performance will be judged in relation to the plan sponsor’s ability to deliver successful retirement outcomes for members. Unfortunately, most fund families have been available only for a short time, and long performance track records are simply not available. As well, the usual caveat applies: past performance may not be indicative of future performance. Having said that, plan sponsors should still consider the following:

  • Did the funds perform as you expected through the recent difficult markets and the rebound?
  • If you were approaching retirement or in retirement, would you have been happy with the performance of the short-dated or retirement TDF?
  • Do you have a built-in performance guarantee? What is the real cost to members (in the form of either additional fees or lost upside potential)?

Investment management fees
As with all investment products offered in a CAP, plan sponsors need to evaluate the appropriateness of the fees charged. TDFs have some unique aspects in this regard, and plan sponsors should ask the following:

  • Generally, are the fees appropriate?
  • Are the fees materially different than a balanced fund or a do-it-yourself TDF? Can you justify the increased fees?
  • Do the fees decrease as the fund gets more conservative, holding more and more lower-cost bonds and cash?

In the U.S., where the target date market has had more time to develop, structures have been created that allow plan sponsors to customize the glide path and, in some cases, even change the underlying funds and managers used in the program. While not for everyone, plan sponsors that are comfortable with this level of management or those that can access outside expertise may find that these structures can allow for the customization not available through “off-the-shelf” products. This approach has the added benefit of leveraging the lower fees and governance structure for the funds already offered in the plan.

Beyond the product features, plan sponsors should ensure that their recordkeeper be able to provide reports on how many members are in the funds, if these members are using the TDF options in conjunction with other à la carte funds, and be able to provide CAP Guidelines-compliant reporting and education materials on an ongoing basis for members.

As these two articles have illustrated, introducing a TDF into a CAP is not as simple as picking the fund with the best performance or lowest fees. Both performance and fees are important, but so are many other features that, over the long term, can have material impact on member outcomes. Plan sponsors need to evaluate and understand the implications of the various design features and be comfortable that, on balance, they are appropriate for the plan membership.

Ryan Kuruliak is a Toronto-based vice-president with Proteus, an investment and governance specialty firm. He has more than 14 years experience in the pension and investment consulting industry.

These are the views of the author and not necessarily those of Benefits Canada.

Copyright © 2018 Transcontinental Media G.P. Originally published on benefitscanada.com

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