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Tool Navigates Sea of Target-Date Funds

Wide Range of Similar Products Can Make Advisers, Investors Dizzy


Target-date funds, also known as lifecycle funds, are rapidly rising in 401(k) plans as the favorite qualified default investment alternative because they're much more appropriate than the traditional money market fund for hands-off investors.

In theory, you simply pick the target date that's closest to when you expect to retire, and you're done. The fund rebalances your asset allocation over time, growing more conservative as you grow older. If only it were that simple.

With 248 different lifecycle fundsto choose from at the end of 2007, according to the Investment Company Institute, plan sponsors can have a tough time selecting the right plan most appropriate for their needs. Even target-date funds with the same target date, such as the year 2020, can range from being quite aggressive to conservative, depending on their glide path.

"The percentage of equity at the time of retirement can vary between 20% and 60%," said David Musto, managing director of retail investment only retirement for JPMorgan Asset Management. "These are fairly significant differences. Until now, there hasn't been a simple construct for differentiating between plans."

According to the ICI, approximately 88% of lifecycle fund assets are held in retirement accounts. Assets in lifecycle and lifestyle funds totaled approximately $421 billion at the end of 2007, up from $303 billion the previous year. Lifecycle fund assets were $183 billion in 2007, up from $114 billion in 2006, or an increase of 61%.

Last week, JPMorgan unveiled the "Target Date Navigator," a new tool that helps plan sponsors sort through all the choices. According to JPMorgan, the navigator is the first framework that categorizes funds according to their glide path strategy and investment composition.

When JPMorgan started looking into the target-date world, it found a disconnect in the alignment of participants' behaviors and needs, plan sponsors' goals and target-date strategy selection. The firm realized that more could be done to help advisers and plan sponsors distinguish between competing funds, while at the same time addressing fiduciary responsibilities in selecting and monitoring those investments.

"This tool fills a necessary void in the marketplace in determining which funds might best fit the particular needs and the goals of each retirement plan," JPMorgan said.

Advisers, plan sponsors and their clients are recognizing the impact of selecting the right target-date approach, Musto said.

When Musto looked at the approximately 40 different target-date strategies in the mutual fund arena, he found they could be categorized into four groups. The navigator's goal is to parse out that universe and categorize the different products into like areas.

"The Target Date Navigator doesn't seek to demonstrate that any one strategy is good or bad, but rather which strategy is the right fit," he said.

Thus, the navigator splits the target-date universe into four quadrants, like the points on a compass.

The northwest sector has funds with higher levels of diversification and less equity at the time of retirement, the northeast sector has higher levels of diversification and higher levels of equity, the southwest sector has lower levels of diversification and lower equity, and the southeast sector has lower levels of diversification and higher equity.

"It's good at helping to describe the different trade-offs," Musto said. "In the hands of independent advisers, this could become the industry standard for target-date fund categorization."

Aliso Viejo, Calif.-based 401(k) Advisors came up with a similar system a year ago for scoring funds and their managers called the Retirement Plan Advisory System. The system's scorecard involves creating customized benchmarks that are based on underlying asset allocations.

"All complex problems have easy-to-understand wrong solutions," said 401(k) Advisors President Nick Della Vedova. The trick is understanding what benchmark to use for which peer group, he said.

The scorecard is broken up into four areas in order to reduce exposure to fiduciary liability for plan sponsors, said Jeff Elvander, chief investment officer for 401(k) Advisors.

Thirty percent of the scorecard looks at style factors, 30% at risk return, 20% looks at peer groups, and the remaining 20% considers qualitative factors, he said.

The scorecard considers things like manager tenure, fund expenses and the strength of its statistics. For example, the scorecard asks if the manager who was responsible for the last five years of performance is still with the fund.

"It makes sense of institutional material and provides a roadmap for identifying managers," Elvander said.

"Is the manager's recent success attributed to luck or to skill?" he asked.

Many managers can outperform a benchmark during a given quarter, but they may have just gotten lucky. Luck is the flip of a coin, he said.

Many skilled managers consistently outperform their benchmarks. He said the scorecard uses analytics, style analysis and risk measures to identify who has demonstrated that skill.

"We do not score funds on absolute performance," he said. The scorecard looks at the median rank, eliminating the high and low quarters.

"In the 401(k) world, it's about procedural prudence," Elvander said.

The scorecard allows participants to make very sound investment decisions, Della Vedova said. It also allows them to evaluate and build their own package so they can have more control over money managers.

Della Vedova said many plan sponsors are seeking customized allocation models that are based on the funds they choose, rather than prepackaged models.

"There is no one benchmark that applies to every fund," Elvander said. "That's why you need custom benchmarks. There is no one single style. They're all different."

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