Glide path philosophy has become a big issue in the U.S., confirms Janet Rabovsky, practice leader, investment consulting, with Watson Wyatt Worldwide.

While each target date fund (TDF) provider has its own methodology in glide path design, the vast majority of products in Canada tend to follow a similar downward curve in the final 20 years prior to a fund’s maturity to achieve a 30% to 40% equity exposure and 60% to 70% vested in money market and fixed income assets. In contrast, U.S. TDFs tend to maintain a more aggressive equity exposure over the course of the glide path to mature at around a 40% to 50% equity exposure.

There are two components affecting the glide path: the asset allocation at the inception of a TDF and how this investment mix shifts through to the target date. The higher the equity exposure and how actively the TDF is managed tends to become a cost factor, Rabovsky observes.

In Canada, plan sponsors often bear part of the investment cost of members, she continues. Thus, the selection of TDF platform often comes down to the cost-effectiveness of the total services offered rather than specifics such as the glide path used. As a result, Canadian TDF solutions tend to be more conservatively managed when it comes to asset allocation and glide path methodology.

The danger with conservative asset growth, however, is longevity/mortality risk and inflation risk. A 2005 study compiled by U.S.-based AllianceBernstein Investments suggests that even the more aggressive growth glide paths of U.S. TDFs may be inadequate in addressing the fact that members live longer than before into retirement. “Our research shows that most target date retirement funds are not providing the high-quality investment planning and asset allocation that plan sponsors, as fiduciaries, should require,” notes the report. “The primary flaw in most existing target date funds is that they invest too conservatively…They hold too little equity and too much fixed income and cash to generate the growth required to fund participants’ spending over what may be several decades in retirement.”

The AllianceBernstein report refers to two typical TDF glide path/asset allocation models in which the equity exposure at retirement is 35% and 50% respectively, based on a 40-year fund. “It takes a lot of equity to generate sufficient growth,” notes the report. “Our analysis of historical U.S. stock and bond data shows that the conservative and moderate equity allocations [in the above models] were likely to generate enough growth to fund spending for only 15 or 20 years.” The report suggests that a TDF’s equity growth exposure for the same 40-year time horizon (with maturity at age 65) should be around 65% to accommodate the risks of inflation and increased longevity.

It’s difficult for those in the industry to know where to stand on this issue. “There is simply no research in Canada showing what is the right or definitive number for a glide path,” acknowledges Stephen Lewis, senior consultant with Towers Perrin. Dianne Lee, a consultant with Hewitt Associates, confirms this uncertainty. “In Canada, we’re still doing the homework to determine whether the asset allocations of TDFs are too conservative.” However, she adds, on the flip side of the coin, there is some feeling among plan sponsors that the current TDFs on the market may be too aggressive in their asset management.

“The rule of thumb when I was a financial planner was that, at retirement age 65, the asset mix of an investment portfolio should be 30% to 40% equity and the remainder in more secure money market instruments,” comments Joan Johannson, president of retirement services with Integra Group Retirement Services. That said, she acknowledges that the risks of longevity and inflation will change over time. “A lot of work is being done in [the Canadian pension] industry to identify the real cost of retirement relative to lifestyle, rather than just going with this ‘rule of thumb’ approach.”

For more details on the evolution of TDFs and future trends, see On Target? in the June 2008 issue of Benefits Canada magazine.