Target-date design: Holding fast to a strategic view in the face of uncertainty

The world is awash in uncertainty, from the uptick in COVID cases around the world to Brexit issues, virus-aid gridlock in the U.S. and the recent U.S. presidential election. The one certainty is that market volatility appears here to stay. The question for long-term investors — both employees saving for retirement and the employers sponsoring retirement plans — is whether this uncertainty and volatility warrants a change in strategic direction. The question is particularly important to the millions of 401(k) participants invested in target-date funds — the most-used qualified default investment alternative — and to the employers sponsoring the plans. The answer from experts is a resounding no, and that’s good news.

“We’re seeing very little in the way of reactionary behavior on the part of plan sponsors, and that’s encouraging,” said Lorie Latham, a senior defined contribution strategist for T. Rowe Price. “They have a clear orientation and anchor to longevity coming first. Meaning, their primary concern is setting up participants in a way that gets them to, and into, retirement with sufficient funds so that they don’t experience a shortfall.”

Latham is also encouraged that participants appear to be sticking to a strategic view and not overreacting to today’s economic and financial market ups and downs. She said that T. Rowe Price’s record-keeping data shows very few participant withdrawals and very few reallocations — in the low single digits — so far in 2020.

Now, keeping to one’s long-term strategic view doesn’t mean target-date managers should sit back and relax in the face of market upheaval.

“We have the ability to modify our strategic positions, in order to take advantage of emerging opportunities, or to be relatively more defensive at certain points in time,” said Wyatt Lee, a portfolio manager in the multi-asset division of T. Rowe Price. Lee said that over the course of the year he has seen opportunities to add to, and then take off, risk positions. However, he said, “What we haven’t seen is anything that might lead us to make meaningful changes to our strategic positioning. And a lot of that certainty is driven by the robustness of our work, looking at a lot of different factors and stress-testing our designs before we implement them. That gives us the confidence that we are well positioned for the long term, even if we take advantage of return or risk management opportunities in the short term.”

SETTING GOALS, PRIORITIZING RISKS

“There are lots of different glidepaths out there to solve for lots of different problems, but until and unless we know the target outcome — and how you are defining and prioritizing risk — it’s hard for a plan sponsor or solutions provider to get a handle on the right design,” Latham said.

According a recent plan sponsor survey by T. Rowe Price, 78% of 401(k) sponsors said that in designing their target-date option, they wanted to make the best decision for everyone. And in prioritizing risk, 64% said longevity risk was either No. 1 or No. 2. Downside and behavioral risks followed, with volatility and inflation risks trailing far behind. Latham said she is encouraged by this data, as it indicates plan sponsors are not anchoring their target-date design on any single cohort of participants. In addition, as far as success metrics are concerned, plan sponsors are much less attuned to market volatility and benchmark risk than they used to be.

“We have come a long way as an industry, and I think plan sponsors are much more astute in their risk orientation, their understanding of the role of the defined contribution plan and what they’re actually solving for,” Latham said.

“The aim is not a design that works really well in the perfect situation,” Lee said. “The aim is a design that works well across a range of different scenarios and different individual circumstances, to make sure that people have the best chance of meeting their retirement needs. I have joked with clients that if everybody started saving 15% of their salary at age 22 and got an 8% market return every year and only needed to take out 4% of their assets annually throughout retirement, my job would be really, really easy. But plan sponsors don’t want us as solutions providers to just solve for the average, they want their target-date solutions to be as broad as possible and deliver successful outcomes across a wide range of individual circumstances.”

A big part of the challenge is identifying the intended outcomes, analyzing the many risks to those outcomes and then stress-testing those risks across a range of portfolio designs. Lee said he focuses on the market and behavioral variables that can influence a successful retirement outcome, how those variables can influence fund design and how they can interact with each other. This approach enables him to model and stress-test realistic portfolio behavior across a range of scenarios, he said.

SHORT-TERM STRESS & THE GROWTH CONUNDRUM

In glidepath design, one of the biggest questions — and potentially one of the most important variables in retirement outcomes — is preretirement derisking: reducing the equity and growth focus in the 10-year window before retirement. In highly volatile markets, sensitivity to that issue can be raised for all stakeholders, including plan participants, plan sponsors and solutions providers.

“Prioritizing risk means not just looking generically at risk over the long term, but also making sure you’re taking the right risks at the right point in time,” Lee said. “In that regard, it’s important to keep in mind that the current environment is extremely focused on a narrow window. However, realistically, when you broaden it out, you have to look at the whole cycle.”

He cites substantial short-term market downturns during the SARS crisis, the European debt crisis and the U.S. debt downgrade, among others. After each of these major events, markets eventually rebounded.

“The benefit of portfolio growth over the long term, to support your ability to generate the desired outcome, is absolutely critical,” Lee said.

“You can’t manage to a single risk only. You have to think about the wide range of risks and variables, and then consider the trade-offs,” Latham said. She said she believes that it’s unhelpful to anchor too much to a worst-case scenario — especially in the midst of one — and then let that drive decision-making, because markets do smooth out over time and cycles do come and go.

“Even in difficult markets, that period of time leading up to retirement is still a critical compounding opportunity, when you presumably have your highest asset balance, your most complex scenario and your highest savings rate,” she said. That means that if you reduce “equity too soon, you may lose an attractive compounding opportunity that has a material impact on your landing point.” ■