PLANSPONSOR - October/November 2018 - 59

spectrum and deeper into equities. He
says most investors have been left complacent
by the strong bull market the U.S. has
experienced in the recession's wake.
McMillan and Lafferty urge long-term
investors to look beyond performance as a
primary driver of portfolio decisions and to
set realistic objectives, remain humble and
remember the real lesson of the collapse.
" Risk, in the form of asset allocation,
debt or what have you, is what gets you
into trouble, " McMillan says. " Even if our
models and predictions fail, if we simply
are not that exposed, the damage will be
limited. " For this reason, plan sponsors
should focus on assessing the risk in their
investment lineup options, in addition to
reviewing returns.
Chasing Equity in TDFs
When considering the DC industry in
particular and the popularity of target-date
funds, experts advise that chasing equity
performance leads to greater sequence of
returns risk. This risk is tied to the order in
which investment returns occur and how
the sequence plays out against the fixed
need of participants to draw retirement
income steadily from a portfolio.
According to Ron Surz, president of
Target Date Solutions in San Clemente,
California, the last 10 years have been
quite strong for U.S. stocks, and so those
TDFs that have carried the most U.S.
equity risk have attracted more and more
investors. But analysis of the holdings of
these funds shows they will be exposed
to the full force of the next downturn,
Surz says.
" Return-chasing leaves retirement
plan investors, even those in TDFs,
carrying more risk than they realize and
more risk than is in their best interest, " he
says. " This potentially puts plan sponsors
at fiduciary risk, because it is their duty to
offer a prudent fund lineup. "
Despite ongoing evolution in the
marketplace, Surz says, most participant
assets in TDFs are still being invested
with large bundled service providers and
with funds that have high Morningstar
performance ratings. Pointing to the glide
paths for these funds, Surz again notes
a significant bias in favor of U.S. largecap
stocks, which explains their strong
performance for the preceding three- and
five-year periods. He also observes that all
three of the largest bundled TDF families
have been reaching the target date with
over 50% in risk assets, " which is not safe
or prudent, " per the CRI data cited earlier.
Anne Lester, head of retirement solutions
for J.P. Morgan Asset Management,
in New York like Surz, speaks to the importance
of prudence, calling this central to
her team's most recent development work
on the J.P. Morgan SmartRetirement
TDF series. She stresses the importance
of plan sponsors looking beyond simple
performance metrics during the retirement
risk zone-the need to give participants
investing opportunities that are
tactical and defensive in the decade that
centers on the retirement date.
Lester says average returns in retirement
matter far less than the sequence of
those returns. As she puts it, poor performance
in the early, versus later, years of
retirement will have a far more destructive
impact on a portfolio's ending value.
Broader Fund Lineups
While TDFs continue to take in the lion's
share of new DC plan contributions-
Lester's firm estimates that " a whopping
88% of new contributions " will flow
into the funds by 2019-the prudence
conversation also extends to the wider
DC plan investment menu, from which
many participants continue to build out
their own custom portfolios or allocate to
alongside a TDF investment.
" We constantly hear clients say they
feel the need to offer only the absolute
best-performing manager in a given
asset class, " says Joe Szalay, director of
defined contribution investment strategy
at BlackRock in New York.
It is seldom wrong to demand strong
performance, Szalay says, but, at the
same time, it is critically important for
plan sponsors to look beyond the top-line
performance numbers on the core menu
and ask, how are returns being generated,
and at what level of diversification and
risk? These questions matter mostly for
active funds, but Szalay underscores the
importance of " always asking where alpha
is coming from. "
" This is especially true when we're
talking about the core menu from which
participants will create custom portfolios, "
he says. " As a fiduciary, you just can't be
offering them funds that generate excess
returns in ways that aren't transparent or
true to the asset classes [those funds] are
being labeled with. When times of stress
inevitably return and correlations start
to break down, people will expect their
portfolios to be diversified and to perform
a certain way, but they may be rudely
surprised by what their funds actually do. "
Along the same lines, Szalay says,
analyzing core fixed-income offerings in
a more sophisticated way is crucial for
investment committees.
" If you look at the last five-year
period, and you take the top-performing
decile of the Morningstar intermediateterm
bond category, the top funds all have
fantastic performance records, " he says.
" But when you take these managers and
compare them across a more sophisticated
matrix that breaks down factors such as
correlation to equities or their standard
deviation, the range [in] how these funds
are put together is just huge. There is so
much more going on under the surface
than just strong performance. "
-John Manganaro
KEY POINTS
* When choosing funds, plan sponsors
should focus on how returns
are being generated and at what
level of diversification and risk-
not just at past performance.
* Analyzing core fixed-income
offerings in a more sophisticated
way is crucial for investment
committees, as how the funds are
put together varies widely.
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