Improved TDFs could lower risk, increase retirement income

According to a report from the Georgetown University Center for Retirement Initiatives and Willis Towers Watson, target-date funds can be modified so that they might improve expected retirement income for individuals through the use of strategic assets that can also lower risk.

The report, titled “The Evolution of Target Date Funds: Using Alternatives to Improve Retirement Plan Incomes,” says that the underlying asset classes in TDFs can be expanded so that they include alternative investment strategies such as private equity, real estate and hedge funds, thus creating a “diversified TDF.”

Those asset classes are common in defined benefit pension plans. But as fewer DB plans survive to be offered to employees, the report says, the returns provided by defined contribution plans can be improved by adding such strategies, when compared with a portfolio of equities and fixed income—which can succumb to volatility and leave workers unprepared.

“Our analysis showed that a diversified TDF could increase the amount of an annual retirement income that can be generated by converting a participant’s defined contribution balance into a stream of income at retirement by between 11 and 17 percent depending on market conditions,” Angela Antonelli, the Center’s executive director, is quoted saying.

That won’t necessarily be a piece of cake, since an increase in diversification in TDFs will require education and oversight, including a range of issues, including liquidity, pricing, benchmarking, fees and governance. However since most workers don’t save anywhere near enough to see them through retirement, the report adds, action to improve retirement outcomes is growing in urgency. New ways to improve on the status quo include holistic planning, including investments, plan design and communication.

DC plans were never intended to replace DB plans as a source of income in retirement, and as a result, their investment operations and oversight “have not yet matured to the level needed to rival those of DB plans,” says the report. It continues, “In addition, plan sponsors may be hesitant to implement changes to their programs given the higher perceived fiduciary risks and concerns about possible litigation.”

But fiduciary obligations, it adds, including such “concerns such as liquidity and pricing, benchmarking, fees and governance related to incorporating alternative investments into TDFs,” can be dealt with “through a careful and prudent process focused on enhancing potential outcomes for participants.”

David O’Meara, head of DC strategy at Willis Towers Watson, is quoted saying, “There is a greater need for the DC industry to support adoption of strategies that will improve expected investment performance. DC service providers’ capabilities have vastly improved. Operational challenges, including the need for daily liquidity and daily pricing, and participant-controlled cash flows, can easily be addressed. This can already be seen in the increased use of custom funds in DC plans.”