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Benchmarking Target Date Portfolios October 22, 2008 Ronald W. Jackson II Investment Consultant. This document is incomplete without the accompanying discussion; it is confidential and intended solely for the information and benefit of the immediate recipient hereof. Agenda.

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Benchmarking target date portfolios october 22 2008 ronald w jackson ii investment consultant l.jpg

Benchmarking Target Date Portfolios

October 22, 2008

Ronald W. Jackson II

Investment Consultant

This document is incomplete without the accompanying discussion; it is confidential and intended solely for the information and benefit of the immediate recipient hereof.


Agenda l.jpg
Agenda

  • What Are Target Date Funds

  • Why Are They So Popular

  • Considerations

  • Benchmarking and Performance Monitoring

This document is incomplete without the accompanying discussion; it is confidential and intended solely for the information and benefit of the immediate recipient hereof.


What are target date funds l.jpg
What Are Target Date Funds

  • Also known as lifecycle or target retirement funds

  • Criteria

    • Diversified portfolio of investment assets based on year of retirement

    • Gradually shifts from aggressive to conservative investment mix

    • General purpose: growth and then preservation of capital

    • Professionally managed

    • Automatically rebalanced

    • Actively or Passively managed


Why are they so popular l.jpg
Why Are They So Popular

  • A significant number of US defined contribution plan sponsors have added Target Date funds to their plan’s investment structure

    • Service providers effectively marketed their own funds

    • 404(c) default choices for auto-enrollment plans include Target Date and risk-based life style funds as one of three protected Qualified Default Investment Alternative (“QDIA”) choices

      • Balanced funds and managed accounts are the other two QDIA options

      • Money market and stable value funds are no longer viewed as a “safe” default choice because they are not considered appropriate long-term investment options for the general employee population



Sample target date options available on a vendor platform l.jpg

LIFE-CYCLE MANAGERS ON AN ADMINISTRATOR’S PLATFORM

Fund Manager

Strategy

Vehicle

AllianceBernstein

active

mutual fund

AllianceBernstein

active

collective trust

AllianceBernstein

passive

collective trust

AllianceBernstein (customized)

custom

collective trust

American Century

active

mutual fund

American Funds

active

mutual fund

Barclays

passive

collective trust

Barclays

enhanced

collective trust

Barclays

enhanced

mutual fund

Capital Guardian

active

collective trust

Fidelity

active

mutual fund

Franklin

active

mutual fund

Goldman Sachs

active

mutual fund

Hartford

active

mutual fund

JPMorgan

active

collective trust

JPMorgan

active

mutual fund

Manning & Napier

active

mutual fund

Manning & Napier

active

collective trust

Mellon

enhanced

collective trust

MFS

active

mutual fund

Northern Trust

passive

collective trust

Northern Trust

enhanced

collective trust

Principal

active

mutual fund

Putnam

active

collective trust

Putnam

active

mutual fund

Pyramis

passive

collective trust

Pyramis

enhanced

collective trust

Pyramis

active

collective trust

Riversource

active

mutual fund

Schwab

active

collective trust

Schwab

active

mutual fund

Seligman

ETF

mutual fund

SSgA

passive

collective trust

SSgA Dow Jones

passive

collective trust

T. Rowe Price

active

mutual fund

Vanguard

passive

collective trust

XTF

ETF

mutual fund

Wellington

active

collective trust

Wells Fargo Advantage

passive

collective trust

Sample Target Date Options Available on a Vendor Platform


Target date fund penetration l.jpg
Target-Date Fund Penetration

Source: PSCA’s 51st Annual Survey of Profit Sharing and 401(k) Plans


Common structures l.jpg
Common Structures

Source: PSCA’s 51st Annual Survey of Profit Sharing and 401(k) Plans


Common structure l.jpg
Common Structure

Source: PSCA’s 51st Annual Survey of Profit Sharing and 401(k) Plans


Considerations l.jpg

Once a plan sponsor elects to add Target Date Retirement funds to an investment lineup, the objectives of this option need to be determined before an investment manager is selected.

Among the considerations should be the following:

Risk level (e.g., tracking error) or alpha generation

Fee considerations

Glide Path - Equity exposure up to and post retirement

Asset allocation

Complexity versus simplicity of structure

Appropriate benchmarking and performance monitoring

Considerations


Slide11 l.jpg

Target-Date Fund Structure — Asset Allocation Path funds to an investment lineup, the objectives of this option need to be determined before an investment manager is selected.

Equity glide paths of the largest target maturity fund families


Slide12 l.jpg

Target-Date Fund Structure — Asset Allocation Path funds to an investment lineup, the objectives of this option need to be determined before an investment manager is selected.

Asset allocation decision has profound implications on participant experience


Slide13 l.jpg

Overall, asset allocations among providers varies for any given target fund.

Target-Date Fund Structure — Asset Allocation Path


Considerations14 l.jpg

Fund companies have flocked to the growing target-retirement market, each trying to present a differentiated product; as a result, deciding on a target date program is far more complex than investing in one.

Considerations


Market trends l.jpg
Market Trends market, each trying to present a differentiated product; as a result, deciding on a target date program is far more complex than investing in one.

  • Plan sponsors have a choice between actively managed and passively managed funds.

Actively Managed Target-Date Funds

  • Performance influenced by manager skill

  • Complexity of structure varies widely

    • Some funds consist of 25+ components

    • Others fund families include seven and possibly fewer funds

  • More structural changes are expected with increased number of funds

  • Structure affects monitoring efforts; difficult to evaluate risk vs. benchmark

  • Higher costs

  • More volatile relative to benchmark

Passively Managed Target-Date Funds

  • Performance more consistent with benchmark

  • Simple structure is easy to understand, communicate and monitor; facilitates meeting fiduciary responsibility

  • Lower likelihood of changes to fund components

  • Low probability of needing to be replaced

  • Best suited for asset mapping and as a low-risk “default fund,” where no 404(c) protection is provided to Plan fiduciaries

  • Lower fees


Market trends16 l.jpg
Market Trends market, each trying to present a differentiated product; as a result, deciding on a target date program is far more complex than investing in one.

  • Now, plan sponsors may have a choice between mutual funds and commingled trusts.

Mutual Funds

  • Registered SEC pooled assets

  • Collective investment vehicle used by a fund manager to trade securities whereby gains or income generated is passed onto investors via dividend or interest

  • Daily valued

  • Transparent

  • Typically higher costs than commingled trusts or separate accounts

  • More commonplace

Commingled Trusts

  • Institutional tax-exempt retirement pools, exempt from SEC regulations

  • Collective investment vehicle maintained by a bank or trust company for the pooling of retirement plan assets

  • Can be valued daily

  • Less transparent

  • Fees are typically lower than mutual funds

  • Recently available


Market trends17 l.jpg
Market Trends market, each trying to present a differentiated product; as a result, deciding on a target date program is far more complex than investing in one.

  • Plan sponsors have a choice between complex or simple structures.

Complex Structure

  • Diversification via high number of underlying mutual funds

  • Often employs multiple managers for a mandate

  • May entail post-retirement participation

  • Typically relies on manager skill to add incremental value

  • Exposure to non-traditional assets and strategies

  • Entails higher level of active risk

  • Higher costs

Simple Structure

  • Small number of investment options, i.e. 10-year increments

  • Low number of underlying mutual funds

  • Underlying funds tend to be very broad market portfolios or indices without style bias or sub-asset classes

  • Emphasis on broad market coverage as opposed to relative performance

  • Given low number of underlying funds, individual fund performance highly critical; typically employed in passively managed plans

  • Lower fees


Market trends18 l.jpg
Market Trends market, each trying to present a differentiated product; as a result, deciding on a target date program is far more complex than investing in one.

  • Now, plan sponsors should understand the implications of the glide path.

Glide Path Philosophy

  • Level of equity exposure that changes over time

  • Biggest differentiator among providers

  • Typically high equity allocation that gradual lowers as participant reaches retirement age

  • Different risks to consider:

    • Opportunity cost

    • Inflationary risk

    • Longevity risk

Customization

  • Ability of provider to customize glide path for your plan’s demographic

  • Ability of provider to utilize current plan options to construct target retirement plan

  • Ability to offer Best-in-class funds

  • Minimize plan size requirements


Slide19 l.jpg

PURPOSELY LEFT BLANK market, each trying to present a differentiated product; as a result, deciding on a target date program is far more complex than investing in one.


Slide20 l.jpg

Overall, asset allocations among providers varies for any given target fund.

Target-Date Fund Structure — Asset Allocation Path

Equity glide paths of the largest target maturity fund families

Fund companies have flocked to the growing target-retirement market, each trying to present a differentiated product; as a result, deciding on a lifecycle program is far more complex than investing in one.

Asset allocation decision has profound implications on participant experience


Comparative illustration of target retirement structures l.jpg
Comparative Illustration of Target Retirement Structures given target fund.

Franklin

Active

Fidelity

Complex

Principal

Active

JPMorgan

Active

Pyramis

Active

Hartford

Active

Wells Fargo

Passive

Wellington

Active

Northern

Trust

Enhanced

Schwab

Active

Putnam

Goldman

Sachs

Active

T.Rowe

SSgA

Dow Jones

Passive

American

Century

Active

Overall Fund Structure

BGI

Passive

BGI

Enhanced

Alliance

Bernstein

Active

Pyramis

Enhanced

Northern

Trust

Passive

XTF

Active

SSgA

Passive

Cap

Guardian

Active

RiverSource

Active

Vanguard

Mellon

Enhanced

Seligman

Active

MFS

Active

M&N

Active

Pyramis

Passive

Simple

Active

Passive

Investment Management (Level of Market Risk)

Note: Excludes customizable Plans.


Illustrative diversification among peers l.jpg
Illustrative diversification among peers given target fund.

* While not invested at present, they are also able to invest in international fixed income and TIPs

** Fidelity’s current EME allocation consists of an investment in the Southeast Asia fund

*** Includes an allocation to the Fidelity Strategic Real Return fund

The peers shown are a number of the largest providers in the target date fund industry. Fund information from prospectus’ located on each company's website as of 9/30/2006: www.fidelity.com, www.barclays.com, www.trowe.com, www.vanguard.com www.alliancebernstein.com, www.cstcfunds.com


Considerations23 l.jpg
Considerations given target fund.

  • Structure and Philosophical Decisions:

    • History: Does a track record matter?

    • Management philosophy: Active or Passive? Custom?

    • Investment vehicle: Mutual funds versus collective trusts.

    • Plan structure: Simple or Complex

    • Aggressive or conservative glide path?

    • Any consideration to allow post-retirement participation in the plan?


Benchmarking and performance monitoring l.jpg
Benchmarking and Performance Monitoring given target fund.

  • Evaluating the performance of a Target Date fund can be difficult:

    • Given the long-term nature of these investments and their very short history, it is too early to say definitively whether or not they meet their objective – providing a participant with sufficient income to live on in their retirement;

    • Differing glide paths and asset allocations also make comparisons difficult; and,

    • Plan demographics and participant needs are unique, making peer group comparisons exceedingly difficult and possibly misleading.

  • However, some benchmark(s) are needed to assess and monitor performance…


Benchmarking and performance monitoring25 l.jpg
Benchmarking and Performance Monitoring given target fund.

  • What is a benchmark?

    • Simply, it is a standard against which the performance of a security, mutual fund or investment manager can be measured.

    • Currently, there isn’t an agreed upon benchmark or standard; however there are several common methods that have been utilized to evaluate performance of Target Date funds:

      • An index, S&P 500 Index

      • Composite fund of funds, i.e. Weighted average of assets

      • An absolute return target, i.e. CPI +3%

      • An average of returns of similar profiled Target Date programs

  • None of these individually may be appropriate but a combination of methods may provide better insight for more informed decision making


Income maturity target allocation funds total risk vs total return l.jpg

Risk vs. Return: Income Target Date Funds given target fund.

36 Months Ending March 31, 20xx

14

12

10

8

Total Annualized Return (%)

6

4

2

0

0

2

4

6

8

10

12

Total Annualized StdDev (%)

Annualized Return to date, %

Annualized StdDev to date, %

Information Ratio to date

Total

Total

Total

Plan A

6.19

3.56

1.74

Plan B

3.35

3.37

1.00

Plan C

6.51

3.81

1.71

Plan D

5.95

2.88

2.07

Plan E

6.59

2.97

2.21

Plan F

6.59

3.17

2.08

Plan G

4.34

0.49

8.79

Income Common Benchmark

6.26

2.98

2.10

Income/Maturity Target Allocation Funds Total Risk vs. Total Return


2015 target date funds sample total risk vs total return l.jpg

Risk vs. Return: 2015 Target Date Funds given target fund.

36 Months Ending March 31, 20xx

14

12

10

8

Total Annualized Return (%)

6

4

2

0

0

2

4

6

8

10

12

Total Annualized StdDev (%)

Annualized Return to date, %

Annualized StdDev to date, %

Information Ratio to date

Total

Total

Total

Plan A

7.41

4.35

1.70

Plan B

4.26

5.76

0.74

Plan C

7.71

6.80

1.13

Plan D

6.44

5.67

1.14

Plan E

8.08

5.33

1.51

Plan F

7.27

4.75

1.53

2015 Common Benchmark

7.10

5.13

1.38

2015-Target Date Funds Sample Total Risk vs. Total Return


2045 target date funds sample total risk vs total return l.jpg

Risk vs. Return: 2045 Target Date Funds given target fund.

36 Months Ending March 31, 20xx

14

12

10

8

Total Annualized Return (%)

6

4

2

0

0

2

4

6

8

10

12

Total Annualized StdDev (%)

Annualized Return to date, %

Annualized StdDev to date, %

Information Ratio to date

Total

Total

Total

Plan A

8.87

8.11

1.09

Plan B

5.38

10.62

0.51

Plan C

8.02

8.94

0.90

Plan D

7.64

8.44

0.91

Plan E

8.96

8.10

1.11

Plan F

7.94

8.96

0.89

2045 Common Benchmark

8.23

8.65

0.95

2045-Target Date Funds Sample Total Risk vs. Total Return



Actively managed retirement date trusts total and excess returns l.jpg
Actively Managed Retirement Date Trusts given target fund.Total and Excess Returns


Actively managed retirement date trusts total and excess returns31 l.jpg
Actively Managed Retirement Date Trusts given target fund.Total and Excess Returns



Passively managed target retirement funds total and excess returns l.jpg
Passively Managed Target Retirement Funds given target fund.Total and Excess Returns


Passively managed target retirement funds total and excess returns34 l.jpg
Passively Managed Target Retirement Funds given target fund.Total and Excess Returns


In summary l.jpg

Investment philosophy and methodology given target fund.

• Investment time horizon

• Ending at retirement

• Post –retirement participant participation

Sources of return

• Active management

• Passive management

• Enhanced indexing

Risk profile

• Glide path over time

• Information Ratio / Tracking error

Diversification

• Traditional asset classes

• Non-Traditional asset classes

• Alternative strategies

Performance

• Benchmark Relative

• Areas of Out/Under Performance

Investment tactics

• Manager selection

• Proprietary funds

• Open architecture (“Best-in-class”)

Portfolio monitoring

• Dedicated target-retirement strategy team

• Quantitative optimizers

• Methodology for benchmark construction

Product structure

• Mutual funds

• Commingled funds

• Separate accounts

Fee structure

• Total expenses – Investment option

• Expense ratios

• Revenue sharing

• Account minimums

In Summary


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