A new study released by Georgetown’s Center for Retirement Initiatives questions whether defined contribution participants invested in target date funds (TDFs) are being negatively impacted by the the lack of alternatives in these products. We agree with their concerns/conclusion.
As a reminder, individuals should have an absolute return objective similar to that of endowments and foundations, which differs from defined benefit plans that have a relative objective (the plan’s liabilities). Unfortunately, only 8 of 41 target date fund managers tracked by Morningstar have any exposure to private equity, hedge funds, and/or real estate. For the most part, those products without any alternatives saddle their participants with mostly traditional fixed income and equity exposures.
The study suggests that the dearth of alternatives has its roots in the lack of internal expertise, poor liquidity (need to have mark-to-market capability), and higher fees associated with these products in an era of growing litigation related to expenses.
Given equity valuations and the current interest rate environment in the U.S., we, too, are concerned that defined contribution participants may be saddled with an inferior product in this environment. Given that DC participants (on average) are already facing a retirement funding shortfall, the last thing that we need is another market correction in a rising rate environment that would adversely impact fund balances.
We think that the inclusion of TDFs in a fund lineup has been a very positive development for the average DC participant, just as auto-enroll and auto-escalate features have enhanced the participant’s experience. However, let’s strengthen these product offerings in order to maximize the benefit.