The target date fund industry became a $1.3 trillion market last year, buoyed by the funds' simple premise, a wide adoption by plan sponsors and increased contributions by employees.
Despite such traction, target date funds are grappling with the same challenges now affecting the overall fund industry: cost pressures, transparency demands and the need to reach the younger investor.
Fund firms can address questions of transparency by adopting an open architecture, multimanager platform, says Todd Cassler, president of institutional distribution, John Hancock Investments.
"If you're going to choose a plan lineup of investments that is going to be best-in-breed, why wouldn't you continue that logic for your target-date offering?" he asks in an interview with Money Management Executive.
In February, the firm released a white paper arguing for open architecture in target date fund construction.
"Today, plan-level best practices call for an open-architecture, or multimanager, lineup of investment offerings, but that line of thinking rarely extends to target-date portfolio construction," stated John Hancock Investments President and CEO Andrew G. Arnott.
"If open architecture is important, then perhaps more target-date funds should be open, incorporating a variety of specialized teams based on their merits."
An edited transcript of the coversation with Cassler follows.
What are some recent trends you've noticed in the target-date universe?
Cerulli reported that roughly $1 trillion is currently sitting in target-date funds. Target date funds, you could argue, is one of the most important investment options.
Then the question is: how are you going to solve for QDIA and all the other characteristics? From our perspective, we think that open-architecture, multi-managed, whether it's active or passive, is the best way to do that. If you think about plan design, when looking at the underlying investment options, it is typically open architecture. Conversely, if you look at the target-date offering, it tends to be closed. So, you have a plan lineup that's basically in conflict with best in breed from an individual investment option. When we get to the target date funds we're not employing that same kind of open-architecture best-in-breed approach.
We think that our model is one that resonates well with the open-architecture, best-in-breed and manager-of-manager framework. Between the different vintages that we offer, we have both lifetime and preservation solutions, ones to retirement and ones through retirement, plus with the open-architecture component we were able to answer a number of the crucial questions that clients are looking to have answered.
What was the rationale behind going public with the recent John Hancock whitepaper on open-architecture?
We've always been open-architecture. If you look at our business, we've been employing this multimanager approach for many years. We have done that throughout traditional lineup, as well as with our target-risk and target-date portfolios. This is not a new concept for our firm.
What we believe is that this is a better way to invest. We think that using an open-architecture, multimanager approach is the best solution for participants. Going back to this idea that if you're going to choose a lineup of investments that is going to be best-in-breed, why wouldn't you continue that logic and make it available in a target-date offering?
Does this strategy address the issue of cost and transparency?
Cost has always been an important component. What has happened is the focus on cost has changed in the order of priority.
Originally, let's say cost was number three or four when you were having a discussion in relation to the underlying investment options. Now, cost may be number one or two, and that's the starting point. There are two things that have become table stakes when it comes to the target-date offering: one is, what is your cost; and two is, are you able to generate the performance? Those two things are key characteristics.
The way that we look at this concept of more is that retirement savers need more out of their target-date funds, so we offer two sets of glide paths. It's about asking questions like, how do you deal with longevity risk, do I have enough money through my retirement, are you concerned about retirement readiness and what do we need to do to preserve my money before I retire? As you get closer to that retirement date, or to retirement, you will have to do everything to protect that principle.
We offer two variations. We have our retirement lifetime portfolios and our preservation portfolios. We also have two open-architecture lineups, both multi managed, that feature indexes or multi-managed active portfolios. We offer both of those solutions. We think that's a better way to build a portfolio.
We are also conscious of the importance of fees, and we have cut fees on multiple occasions. Most recently, in January, we cut the expenses by nine basis points on our Multi-Index Lifetime and Multi-Index Preservation portfolios. So, to your earlier question about whether or not you can build a portfolio at a reasonable or low-cost in an open-architecture capacity, we think we have been able to do that at a really competitive fee.
Is there any sort of strategy for blending a solution that has both active and passive offerings?
We look at that and how to build a portfolio using a variety of investment tools; whether that's single factor or multi-factor, or traditional active portfolios. We are always looking at different ways to combine portfolios. It just depends on which portfolio you are looking at. In our variable insurance trust asset allocation portfolios, which are multi-managed, we use smart beta ETFs. We've been a big user of liquid alternatives in our portfolios for many years. We think that they offer some unique return benefits to shareholders. In addition, they provide non-correlated sources of return, so our model of going out to find the best managers in an individual asset class and then blending them together, If you look at institutional portfolios - DB plans are the largest in the world - they have been using alternatives for years as part of their portfolio construction. We have seen the benefit of that so we have made them available on our products.
Are target-date funds built to be the core constituency for a retirement or pension plan?
Obviously the target-date fund is designed to meet some objective. As you go through the glide path, the asset allocation changes over the course of time.
If you think about it, a core investment vehicle tends to be based on risk-tolerance - what it is your risk tolerance and what is it that you are trying to achieve from an outcome perspective; conservative, progressive or moderate? What you may see is a pairing of target-risk or target-date. If the core portfolio is some type of target-risk portfolio, then you would have this other vehicle attached with a glide path or adjustment. As the core investment, that's not what they are being used for today.
Is the multi-manager strategy a way to diffuse some of the legal issues plan sponsors have run into?
It definitely can help with that. We live in a world that's a heightened fiduciary, so being in open-architecture, the Labor Department has provided some nice guidance around that. So, we think that should help mitigate some of the risk that may come up, as it relates to the regulations.
How are target-date fund providers reaching younger investors?
The first thing you have to start with is: who is doing the communication with the underlying participant? Most of that starts with the plan sponsor. As an organization that's making target-date funds available through a plan sponsor or through a consultant, one thing we are going to do is make available participant level materials that will help with that discussion.
Some of the responsibility, and some of the interaction, is going to come from the plan sponsor. We are going to be one of the education tools as part of that discussion.
The other piece is: you also have the record-keeper that's participating in that. One of the challenges is that there is no a single individual or organization that's going to have the ability to drive that. It's going to be multiple organizations or parties involved in that process.
As the asset manager who is managing the target-date funds, we are going to produce the materials and the various values-add pieces necessary to support it. That may be around the importance of investing over time, but it is obviously multiple constituents that have a role in getting people to save and invest in their futures.
Are there things target-date fund providers see from those strategies they think is something they could learn from?
Obviously digital advice is growing. It is much like online banking. If you think about online banking many years ago, the web banks were going to take down the bricks and mortar banks. But what happened? The big banks recognized very quickly that this was a service and a solution that people wanted. Now, it has been incorporated in the overall banking experience. You have a choice by which how you want to engage with your traditional bank. In some cases, you don't even know that the digital experience even exists. It's just part of the overall prices.
One of the things we see is that the digital advice will be woven into the overall client experience and that will bend the cost curve. You will have certain components that will be digital, others that will be traditional advice and guidance, and the consumer really won't know the difference versus recognizing that it's a standalone digital advice platform.
Firms like Betterment started out with offering no financial advice, and just the digital platform. Well, what has happened? They have now started to add some kind of financial advice; you can talk to somebody. I think that's the part that is still uncertain as it relates to millennials.
Millennials, in general, don't have a lot of money today. They haven't gone through the various changes of life with family and children, or started thinking about different things like estate planning that will be a massive transfer of wealth from the baby boomers.
What happens when they actually have complex solutions that they have to solve for, or substantial money? They are going to look for some form of financial advice and guidance, and they are going to want to talk to somebody. The question is: what does that engagement look like? I don't think you will ever replace the human interaction, especially as it relates to complex problems.