Active,
Passive or
custom?
Choosing the right target date strategy for
plan participants
With their emphasis on one-stop diversification and active asset allocation,
target date funds (TDFs) are taking center stage in DC offerings.
The DC landscape, however, faces a fundamental dilemma. While everyone from
plan sponsors and recordkeepers to investment managers and advisors is trying
to increase the certainty of participants’ retirement income, the participants themselves still determine how much to save, where to invest and when to withdraw
from the plan. Building a successful target date approach requires an understanding of the interactions among participants’ inputs into the DC dilemma.
16
J O U R N EY Fall 2011
Target date funds are poised to
dominate the DC market
TDFs are set to become the primary
investment vehicle in DC plans. Currently, TDFs make up about 11% of the
$4.9 trillion DC market and are forecast
to grow to 40% to 60% of the market
by 2015, according to a September
2010 McKinsey & Co. report, “Winning in the Defined Contribution Market of 2015.” Meanwhile, nearly 70%
of plan sponsors have chosen a TDF
for their Qualified Default Investment
Alternative (QDIA), according to Callan
Investments Institute’s 2011 Defined
Contribution Trends Survey.
Plan sponsors are implementing
TDFs in a number of ways. Some are
opting for an unbundled, or “open
architecture,” approach over an off-theshelf, single manager approach. Others
are adding passive blend approaches
in their TDF design that combine
active management in less efficient
markets and asset classes with index
management in more efficient areas,
such as U.S. stocks. Meanwhile, as more
plan sponsors consider strategies like
re-enrollment to drive more assets
into the QDIA, some are evaluating
customized TDF solutions where they
can tailor a glide path for their participants or use the existing managers in
their plan line-up.
Making sense of the target date
funds universe
With over 30 different TDF approaches to choose from, selecting the appropriate solution for a specific plan can
be challenging.
J.P. Morgan Asset Management’s
Target Date Compass is a tool that can
help plan sponsors and their advisors
compare TDFs across providers and
identify those that most closely align
with their overall goals. Using publicly
available information, each fund family
is mapped into one of four quadrants
based on its percentage of equity exposure at the projected retirement date (Xaxis) and the level of asset class diversification across the TDF suite (Y-axis).
As Exhibit 1 illustrates, there is a wide
variance in TDF objectives. The level of
equity at retirement, for example, can
EXHIBIT 1: Same target, different bull’s eye
Diversification, equity exposure among 2010 TDFs can vary widely
12
Asset class diversification
11
10
9
8
7
6
5
5%
NW
SW
15%
25%
NE
SE
35%
40%
45%
55%
range from less than 10% to as much as
65% in 2010 TDFs.
Many TDFs have changed their
strategies in response to the financial crisis. In 2007 and 2008, for example, many of the TDF managers in
the Southeast quadrant (higher equities, lower diversification) shifted up
on the model as they added more asset classes, while more investment
firms also launched new TDFs in the
Northeast quadrant (higher equities,
higher diversification). In 2009 and
2010, TDFs continued to shift upward,
but there was also a slight shift to the
center axis as managers reduced their
equity exposure in response to market volatility and the financial crisis.
This year, more TDFs are moving from
the south to north quadrants even
as more firms launch TDFs in the
Northwest quadrant (lower equity,
higher diversification).
Where the TDFs are in their respective quadrants will shed light on their
glide paths. As Exhibit 2 illustrates,
TDFs in the Northeast quadrant continue to hold higher levels of equity
at retirement, while TDF managers in
the Southwest quadrant tend to have a
more conservative approach and typically pare back the equity positions to
about 20% at retirement.
Choosing an appropriate target
date fund
65%
75%
Percent of equity at retirement
Data as of December 31, 2010.
Powered by Lipper, a Thomson Reuters Company. Of the mutual funds available in Lipper’s databases, as of 12/31/10, 47 fund
suites were identified by Lipper as open end target date funds and are available for purchase by qualified retirement plans.
(The ETFs—iShares and TDX Independence Funds—are excluded.) Percentage of equity exposure among 2010 TDFs at age 65:
Strategic allocation to non-fixed income asset classes at target date, typically age 65. Asset class diversification: Determined
by exposure, across each company’s suite of target date funds, to 12 separate asset classes as reported to Lipper through
asset allocation, capitalization, credit quality, sector, region and country data as well as underlying fund categorization. Please
see the Target Date Compass Methodology booklet for additional information.
The first step in selecting a TDF
starts with defining the goals for the DC
plan as well as the desired outcomes for
participants. The next step is to identify
the TDFs that seek to produce outcomes
that align with those goals. Conducting
due diligence on those funds that are
in alignment with your goals is the
final step.
To determine realistic plan goals,
plan sponsors will need to examine
what they know and don’t know about
the current environment and their plan
participants. What’s known, for example, in the current environment is that
J.P. Morgan
J OU R NEY
17
EXHIBIT 2: Target date fund designs are
based on different goals and
assumptions—Representative
allocations of target date fund
approaches for comparison
Insights into participant behaviors and their
implications for DC investments
5% Saving for
emergency fund
12% Paying off/down mortgage
10% Paying off/down credit cards
17% Saving for retirement
Percent
100
60
80
40
Percent
Source: J.P. Morgan Retirement Plan Services, 2010
60
Participant Survey.
20
0
25
30
35
0
40
40
25
45
50
55
60
65
70
75
25
30
35
40
45
25
30
35
40
50 55 60
Age
45 50 55
Age
65
70
75
80
60
65
70
75
80
50 55 60
Age
45 50 55
Age
65
70
75
80
60
65
70
75
60
65
70
75
80
60
65
70
75
80
100
100
80
80
60
60
40
40
20
20
0
25
0
30
35
40
45
25
30
35
40
80
Southwest Quadrant
100
80
60
30
35
40
40 45
20
50 55
Age
60
65
70
75
80
80
Percent
Percent
continued on p. 19
J O U R N EY Fall 2011
0
Northeast Quadrant
plan sponsors are the20 planAgefiduciaries familiar with the best ways to use lump
and that 401(k)s and DC plans are fast sums to extend retirement income.
0
30 35of40retire45 50 55There
60 65 are
70 also
75 80many unknowns, such
becoming the primary 25source
Age
100
ment income outside of Social Security. as what the market environment will
The unknown
be like when participants start making
80 variables in this case include future legislative changes.
withdrawals.
100
60
When it comes
to participant char- Choosing the appropriate strategy
80
acteristics, plan
sponsors
know basic requires an understanding of how re40
demographic data, such
as partici- tirement outcomes are shaped by the
60
20
pants’ age, income
levels, average ten- TDF design and performance. In our
40
ure and contribution
levels.
Among view, outcomes are largely shaped
0
25 30 35 40 45 50 55 60 65 70 75 80
the “safe” assumptions
they
can
by how a TDF manager approaches
Age make:
20
participants aren’t saving enough for three key considerations: the riskretirement, many will 0start
adjusted
potential, volatility
25 30 making
35 40 45 50
55 60 65 return
70 75 80
withdrawals from the plan between the Age
management and the level of equity
ages of 59 ½ and 65, and most aren’t exposure at retirement.
18
Percent
20
0
Percent
49% Paying
monthly bills
80
40
20
Percent
100
60
40
0
25
30
35
40
45
50 55
Age
Southeast Quadrant
100
80
100
60
80
40
60
Percent
2% Saving for
children’s education
80
60
Percent
1% Other
100
80
Percent
5% Paying off/
down car loan
Northwest Quadrant
Percent
Daily expenses are most important
Top financial priority
100
quarter of 2008. Meanwhile, only 17% of plan
participants say that saving for retirement is
a top financial priority, a distant second to
paying monthly bills, according to a J.P. Morgan 2010 Participant Survey.
In another sign that plan participants are
largely “accidental” investors, about 37%
of new participants in J.P. Morgan’s recordkeeping complex in 2010 joined their DC plan
through sponsor direction. In many cases,
investors aren’t maximizing the company
match or making the full contributions for the
year. Indeed, participant engagement—using
online advice tools, contacting call centers to
ask questions and checking balances—only
starts to pick up closer to retirement. And
within a few years after retiring, most participants—particularly those with larger balances—tend to quickly pull their assets out of
the plan.
For plan sponsors, participant behavior
can have implications for investment selec100
tion. Participants’ lower engagement levels,
for example, increases the importance of
80
single, one-stop solutions for participants to
make easy decisions. Meanwhile, plan spon60
sors may want to provide a range of solutions
within the core line-up for participants40who
are accumulating assets and also for those
20
who are in the decumulation phase.
Percent
One of the key insights learned from
J.P. Morgan Retirement Plan Services’ participant survey is that participants remain
“accidental” investors and saving for retirement is a distant second compared with other
financial priorities.
Consider participants’ responses to the
2008 financial crisis. According to the firm’s
survey, less than 10% of people actually
made any changes in their plans in the fourth
20
0
25
30
35
40
40 45
20
REITs
0
Emerging Equity 25
U.S. Fixed Income
Real Estate
50 55
Age
EAFE
U.S. Large Cap
High
Emerging
30 Yield
35 40 45
50 55Debt
60
Age
TIPS
Commodities
Cash
U.S. Small Cap
Source: Industry prospectuses
65
70
75
Legislative Corner continued from p. 5
Plan Sponsor Playbook continued from p. 15
income, as well as enabling older
workers to continue working on a
reduced basis even while they are
in retirement “pay” status.
Bob: There’s great discussion in
Washington and across the country about deficit reduction. Can you
share some perspectives around employee benefits and deficit reduction?
jim: This, of course, is extremely
timely with the Joint Committee
on Deficit Reduction developing
its proposals by Thanksgiving, and
Congress directed to pass legislation
by Christmas. The tax preferences
for employee benefit programs are
squarely part of this discussion.
This year, the Federal government
estimates that the tax expenditure—
the lost tax revenue—for employerprovided health coverage is $177
billion. The exclusion for employersponsored defined benefit pension
and defined contribution plans totals
$112 billion.
A critical question is whether policymakers view the tax expenditures
for the employer-sponsored benefits
system as sources of revenue to reduce the deficit or a great bargain because the private employer-sponsored
system relieves financial pressure on
Social Security and Medicare. We are
very engaged in the dialogue on behalf of our members and the millions
of Americans they represent. These
are important issues that can affect
the retirement landscape for generations to come.
re-enrollment has resulted in a
96% participation rate—a 20% increase from 2008. Additionally, the
decision to map participants into
target date funds has resulted in a
more appropriate distribution among
the target date funds, equities and
the less aggressive options available
Active, Passive or Custom?
continued from p. 18
Plan sponsors also need to consider how the TDF strategy aligns with
the plan’s objectives. TDFs with higher levels of equity across the glide
path will typically result in higher
account balances at retirement but
with potentially more ups and downs
along the way. Conservative TDFs,
meanwhile, may sacrifice potential
upside but benefit from lower levels
of volatility.
Designing a custom target
date solution
Larger plan sponsors—generally
those with more than $500 million
in DC assets—are moving today to
a custom TDF approach where they
have the ability to build a glide path
designed for their participants or
can use the existing plan’s manag-
in the plan. In fact, across younger
age groups, the average allocation to
stable value is now below 10%—-half
of what it was in 2008.
Even more encouraging, however,
is the anticipated impact of these
design changes on participants’
level of retirement readiness. Not
only have income replacement
levels increased from 32% to 74%,
but also half of all participants are
now on track to achieve greater financial security by receiving at least
70% of their current income replacement in retirement.
ers. Custom TDFs may also allow
plan sponsors to include alternative
investment structures, such as insurance contracts, hedge funds or direct
real estate investments.
Building a custom TDF portfolio can
also allow plan sponsors to get
more precise about setting their glide
path objectives—whether, for instance,
they want their glide path to be
managed “to” or “through” retirement.
Looking forward
A successful retirement program
provides the most employees with
the highest probability of maintaining their standard of living in retirement. Plan sponsors must establish
realistic goals at the onset and consider a range of criteria, such as the
current investment environment and
participants’ demographic data. Furthermore, as more plan sponsors take
into account participants’ engagement levels throughout their working
years, there are opportunities to build
better plan line-ups through customized approaches or by adding strategies to address longevity, volatility
and purchasing power risks.
J.P. Morgan
J OU R NEY
19
Each issue,
we answer
questions we
receive from
readers.
Please send
your questions
to: journey_
magazine@
jpmorgan.com
How can you improve
target date fund adoption
among your participants?
Despite plan sponsors’ efforts to introduce target date funds into
plans, the level of adoption among participants is still strikingly
low. What can fiduciaries do to improve plan adoption rates?
In Fiduciary implications: Using re-enrollment to improve target
date fund adoption, Fred Reish, partner, Drinker Biddle & Reath,
LLC, offers insight on the strategies plan sponsors can consider
when seeking an increase in the level of target date fund
adoption in their plans. The white paper provides analysis of
target date implementation options and discusses the fiduciary
implications of plan sponsor decisions.
You can download a copy of the paper at
www.jpmorganfunds.com/jpmfdocs/wp-re-enroll.pdf
J.P. Morgan Asset Management is the marketing name for the asset management businesses of
JPMorgan Chase & Co. and its affiliates worldwide.
Publications referenced in this material are presented
for general educational purposes only. JPMorgan
and its affiliates did not receive any compensation or
consideration for referencing these titles. The opinions and information presented in these titles do not
necessarily reflect the opinions of JPMorgan Chase &
Co. and its affiliates.
This document is intended solely to report on various
investment views held by J.P. Morgan Asset Management. Opinions, estimates, forecasts and statements
of financial market trends that are based on current
market conditions constitute our judgment and are
subject to change without notice. We believe the
information provided here is reliable but should not
be assumed to be accurate or complete. The views
and strategies described may not be suitable for all
investors. References to asset classes and financial
markets are for illustrative purposes only and are
not intended to be, and should not be interpreted
as, recommendations. Indices do not include fees or
operating expenses and are not available for actual
investment. The information contained herein may
employ proprietary projections of expected returns
as well as estimates of their future volatility. Any forecasts contained herein are for illustrative purposes
only and are not to be relied upon as advice or interpreted as a recommendation. Discussions presented
should not be construed as legal opinions or advice.
You should consult your own attorney, accountant,
financial or tax advisor or other planner or consultant
with regard to your own situation or that of any entity
that you represent or advise. Past performance is no
guarantee of future results.
J.P. Morgan Asset Management is the marketing
name for the asset management business of
JPMorgan Chase & Co. and its affiliates world wide.
IRS Circular 230 Disclosure: JPMorgan Chase & Co.
and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained
herein (including any attachments) is not intended or
written to be used, and cannot be used, in connection
with the promotion, marketing or recommendation
by anyone unaffiliated with JPMorgan Chase & Co.
of any of the matters addressed herein or for the
purpose of avoiding U.S. tax-related penalties.
© 2011 JPMorgan Chase & Co. All rights reserved.