Being 'beautifully boring' is a source of pride for many money managers.
In James Lauder's case, he interprets the knock as an acknowledgement that in his investment advice, he keeps things simple. "Professional investment managers want to think that they are so smart," says Lauder, CEO of
Advisors have gotten better at evaluating target date funds, but he says it remains difficult because a uniform benchmark approach toward target date funds isn't available.
In a conversation with Money Management Executive, Lauder discusses target date funds and why he doesn't manage money to earn the peer respect of other money managers.
You have a self-avowed passion for performance and risk in target date funds. Can you explain that?
In our product space there's a big disconnect between what people are using to judge their performance and monitor their target date funds with what's really in the best interests of participants. We're still trying to use a lot of the same old tools and looking at the same old funds -- so a heavy focus on absolute returns of these funds over time. You have a period like the past six years where the market's been straight up and there's very little risk in equities, it's really not a fair portrayal of what the real risk might be for the participant.
It's one thing we work hard with, not only with prospects but existing clients, when you choose to set up a fund on behalf of your participants, what you should be doing long-term is looking at those funds and seeing how good a steward they are. For each risk they are taking on behalf of a participant, are they squeezing out as much return as they can, and not just taking more risk over time because markets are going up, and they are trying to compete and prove their peer group ranking. We spend a lot of time talking to people about that, so they don't lose sight of how much risk they were willing to take in the first place.
Is there a benchmark approach, then, or is it up to the individual?
There's no easy approach. There are benchmarks out there. You have the Dow Jones target date indexes, which are more of an outcome-oriented benchmark. So for example, for this level of risk, this is a very good outcome for a well-balanced portfolio. But unfortunately that level of risk isn't the same for every set of funds that are out there in the target date space. Even if you look at the S&P target date indexes, they're an industry average as far as allocations, but again it's a peer group-based benchmark. So unfortunately it does come down to being very specific. As the plan sponsor or advisor in terms of what you're trying to accomplish, that means making sure that philosophy is intact on a regular basis and that you're being a good steward.
There's a lot of peeling away layers of the onion with that, so if they're not as efficient with that level of risk that I thought they would be, I can figure out what's the cause of that. Maybe there's something with the asset allocation, or maybe it is a specific underlying fund or two that are underperforming. So unfortunately there's never going to be a one-size-fits-all benchmark. It requires a bit more subjectivity when you evaluate a target date fund to make sure that they are doing a good job.
What could the industry be doing better with target date funds?
There are a lot of good providers in this space, and a lot of them have the best of intentions. I think the issue is still in the benchmarking piece of it. We still see a lot of advisors over the past six years developing their own, much more robust ways of evaluating target date funds, and that's been a huge improvement, because they're able to have much more meaningful discussions with plan sponsors about performance of the funds.
Who should be more cautious? The advisor or the asset management firm?
It's perfectly okay to provide different flavors and have your own philosophy. I think there's some very smart managers that have funds a lot more aggressive than ours. But they can articulate what that philosophy is, and can articulate how their funds are supposed to be used, and what the ideal participant looks like. And that's okay. This category is going to have a wide range of opinions on how much risk is appropriate.
Again, I think it's the advisors. They're the ones out there on the front lines, they're the ones telling that story, and doing quarterly reviews with their plan sponsors. So I wouldn't say it's a lack of responsibility on the part of the managers, I think we need to make sure the advisors that we work with are always armed with the information they need to make inquiries on behalf of plan sponsors.
Has the proliferation of product choices in the marketplace made it harder for an advisor to decide what's best for the plan sponsor?
They're actually getting better. They have developed their own tools and their own flavors of target date fund evaluation that incorporate a lot more measures of efficiencies -- they're looking at upside versus downside capture, Sharpe ratio, risk-adjusted returns -- and we've had several that have expanded their window. They know they've got to expand from three to five years to seven in a bull market cycle.
That's not to say it isn't difficult. There are just so many varieties out there, not just absolute equity levels, as far as glidepaths, but also in terms of extended asset classes that people are getting into; how do you account for equity versus fixed-income, for example. Now when you add things in like emerging markets debt, high yield, even TIPS has a great degree of volatility, how do you account for it? So as you evolve, the processes you use to evaluate these funds has to evolve along with it. Again it comes down to the advisors and the plan sponsors to keep a sharp eye on what they've got and that the products are still relevant.
How do you rate the products coming into the marketplace now? Do you see quality or quantity?
There's both. Everybody jumped into this space after 2006, and you had a lot of garbage that did come into the market because you had a government stamp of approval. So every provider wanted to have a product. There are so many moving parts, when you think about asset allocation, demographics, glidepath, investor behavior -- all of that has to be built in. To be able to launch a product like that in three months and think it's top of the line is just foolish. We spent two years working on our process and launched in 2005. Seems like we got it right as we haven't changed our process since then.
But there are some really good solutions out there. It's good to have that variety out there, it's good to have people who go back and forth to debate their philosophies on how much risk is right. I think it's healthy for the industry.
Where in the debate between passive and active does your firm find itself?
We've been accused of being beautifully boring. We don't use any of the extended alternative asset classes in our modeling. Where we get a bit more robust than others is where we put the basic asset classes to hedge equity risk. We're constantly looking at the relationship between global equities, global income and cash, and adjusting the mix in order to mitigate downside volatility in the equity markets. Not to sound overly simple, but the best hedge against equity risk is to hold less equity. You don't want to go expose someone more than 30%. It's much easier to adjust your equity holdings as opposed to being 80% in equity holdings and trying to find some magic asset class that's going to offset that downside volatility. That's just dumb.
We focus on getting the glidepath right on the front end. You get that wrong, there's no amount of sexy risk mitigation or optimization you can use. So where do I fit? I try to get the blocking and tackling right, and not try to be the sexiest provider out there. Just get it right, and do the right thing, day in, day out, over the long haul you'll be better off.
Some newer firms would certainly call that an outdated approach.
I'm fine with that. There's no new asset class under the sun. It's funny. The professional investment managers want to think that they are so smart. But you look at these asset classes, they always add them after two or three years, chasing returns. They're doing the exact same things we're telling investors not to do.
Most people would be so underweighted if things that people know and are familiar with had great risk and return characteristics -- emerging markets, small caps. They'll underweigh those and go headlong into whatever the next exciting flavor is. Get people meaningful exposures and asset classes. Make sure you're defining risk first of all and then managing risk. You're going to do much better overall than trying to be the most interesting provider out there, grabbing all the headlines. They're the first to have double-levered pork bellies. That's great. Get your headline, get it out of the way and be happy. You're not doing the right thing for investors.
You don't feel pressure to at least look at those products?
You do sometimes. I don't manage money for the other managers out there. I manage money to do the right thing for individuals. I just don't buy into it.
We always joke around our shop that one thing we know that nobody else knows is that, 'No we don't know.' I think as an industry we like to pride ourselves on being the smartest people in the world, and it's just not true.
If you can get the blocking and tackling right and you have a philosophy that makes sense, which is do to the right thing, that's going to get you a lot further down the road and help you keep your clients a lot longer. You can be tricky and cute, but that doesn't last long.
You have to agree that the market has very much sided with passive products.
After 2008, it wasn't just about riskiness. The wakeup call was also on transparency and repeatability. In target date funds, people just want to understand what your philosophy is and how you run the money, so that down the road they aren't going to be surprised. In a defined contribution plan, switching out of an emerging markets manager, nobody's going to raise an eyebrow about that. But in the target date space, there's much more of an emotional connection. It's not something you want to be surprised by.
