The use of passive target date funds in defined contribution plans continues to grow, in part due to their low cost relative to other TDF options.
“There’s been a significant interest in move of assets to so-called passive target date funds, or index target date funds,” according to Jake Gilliam, senior multi-asset class portfolio strategist at Charles Schwab & Co.
Gilliam visited ThinkAdvisor’s office to discuss why plan sponsors and advisors should look beyond just the low cost of passive TDFs and dig deeper in their due diligence. Gilliam recently co-authored a white paper for Schwab that highlights three misconceptions about passive TDFs.
“Plan sponsors — as fiduciaries to their plan — are often very concerned with price,” Gilliam told ThinkAdvisor. “We also want to encourage them to be as concerned with the fit of the target date fund, the underlying glide path, the design of the target date fund.”
Misconception No. 1: Passive TDFs are always a safer fiduciary choice.
Prudent TDF selection is about process, not just pricing, according to the report.
“As a plan fiduciary, you can’t just look at cost. There’s much more to the story,” Gilliam explains. “Cost is important. Cost is incredibly important, but it’s just one thing.”
Going passive and low cost may seem like “the easy choice,” but it does not absolve fiduciaries of their due diligence and ongoing monitoring responsibilities, according to the report. The report states that “low fees alone are unlikely to be in the best interests of the plan fiduciary if the overall TDF design is a poor fit.”
Rather, as the report continues, a fiduciary must consider all aspects of TDF design to ensure the option is well suited for the plan.
For example, risk decisions around equity levels as well as allocations in more volatile sub-asset classes, such as emerging markets securities and high-yield bonds, should be conscious and deliberate.
According to the report, the slope of the glide path can lead to significant differences in risk and results over the multi-decade time horizon of TDFs.
Over-relying on fees as the primary selection driver without these sorts of considerations fails to offer the same degree of protection, the report states.
Misconception No. 2: Passive TDFs are always a better choice for investors.
Passive TDFs vary widely in risk/reward profile based on the many decisions that go into portfolio design, according to the report.