Asset Allocation
Themes in ERISA* litigation continue to shift away from fees to a focus on results. Last year, cases were brought against a prominent passive provider. This year, a large active provider is in legal jeopardy after allegations of chronic underperformance. While none of these cases have yet proved their merit by moving past the motion to dismiss, the spotlight on results gives plan fiduciaries a strong reason to consider their target date fund (TDF) selection and monitoring processes.
Fundamentally, the question must be asked: Should a decision as important as selecting a TDF provider, with which a participant could be invested for 70 years or more, really be primarily focused on costs? Or is a more comprehensive view needed, one that considers fees, outcomes, and the ability to smooth market volatility? Indeed, looking at the last 10 years of history, the variability of results in the TDF industry is more than three times the difference in fees.
Dispersion of target date fund returns far outpaced difference in fees
This isn’t a random selection process, with superior results that can be dismissed as mere luck, as history shows some providers have demonstrated a persistence of returns. Although past results are not necessarily indicative of future returns, considering long-term metrics can provide a lens into a target date provider’s historic consistency. In return, this can help fiduciaries establish a process for choosing which TDF provider seems most likely to help participants achieve their retirement goals. With that in mind, consider risk-adjusted returns, which incorporate both returns and volatility. Consistently high Sharpe ratios† versus peers can help indicate the value in an investments’ returns given the level of risk.
In the paper linked below, we take a closer look at the long-term consistency in the American Funds Target Date Retirement Series® in terms of both return and risk, illustrating how it seeks to drive better outcomes for participants.
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*The Employee Retirement Income Security Act (ERISA) is a federal law enacted in 1974 that protects the retirement assets of American workers, implementing rules that qualified plans must adhere to and ensure that plan fiduciaries do not misuse plan assets.
†Sharpe ratio uses standard deviation (a measure of volatility) and returns to determine the reward per unit of risk. The higher the ratio, the better the portfolio’s historical risk-adjusted performance.
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