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Q&A: Smarter Target Date designs can help participants to land where they expected

It’s critical that plan sponsors review their target date funds and meet with fund managers regularly to ensure the glide-path strategy continues to match their needs.

As a growing number of employers move away from defined benefit plans toward defined contribution plans, it’s critical that a participant’s investment risk match their stage in life. Well-designed target date funds aim to do just that. This is of critical importance, since target date funds will constitute 35% of all 401(k) assets by 2018.[1] Jeremy Stempien of QMA — the company that manages the asset allocations underlying the Prudential Day One Funds — explains the reasons target date strategies vary in degrees of active and passive management, and why the lessons of 2008 still matter.

What should Plan Sponsors be looking for when evaluating target date funds? How important is the glide path as a consideration?

The glide path is perhaps the most important consideration for evaluating target date funds. Fund managers talk about their process for “de-risking” as participants get closer to retirement, but every target date fund essentially embraces that philosophy. To us, the true measure of a glide path is simply the average level of equity at every age rather than other characteristics, such as underlying asset allocation or manager implementation. Those involve a completely separate set of considerations outside of how much equity is offered. So when selecting a target date series, it makes sense for plan sponsors to start by defining appropriate equity levels for their participants, determining for their people what’s high and what’s low. They can then get to know the asset allocation within the glide path and, of course, the managers who will implement the strategy within the funds.

Are glide paths static or do they change over time?

This is a complex and important question that plan sponsors need to consider. Target date glide paths can change significantly — and investors and plan sponsors are often unaware when they do. That can put additional fiduciary risk on plan sponsors if they selected a certain glide path and it turns out the glide path is no longer being managed in that way. So it’s important for plan sponsors to regularly monitor and review their selected target date series to make sure the investing strategy behind the glide path continues to match the needs of plan sponsors.

That doesn’t sound like something you’d want to be surprised by.

Absolutely. Think about the market turmoil in 2008. Many plan sponsors with older employees invested in their 2010 fund — with what they believed were “conservative” allocations — probably assumed their participants would ride out the correction okay. Only after participants lost large portions of their balances did some discover the series had become far more aggressive than they thought. That’s just one example, but it underscores the need for plan sponsors to monitor and even meet with their fund managers regularly.

Does 2008 hold any other lessons for plan sponsors?

Obviously it’s essential for plan sponsors to know how stable their glide path is. For many it’s critical the funds continue to be managed in the manner they initially agreed to. But the reality is that it’s not always the case. So plans need to ask this question in order to understand how the glide path might change depending on the market. Will the manager take on more risk if returns decline? Will the retirement income of participants go down? I don’t think those conversations happened before 2008. I think plan sponsors are now having these conversations more, so they know what to expect.

What should plan sponsors be looking for in a glide path?

There isn’t necessarily a right or wrong glide path. When evaluating glide paths from different target date providers, plan sponsors should try to find the one most appropriate to the needs of their participants. Thinking about the unique makeup of their participants, about their evolving risks, and attempting to qualitatively determine what type of glide path philosophy best fits will increase the probability that the sponsors will choose a glide path that’s right for their plan. Because not all glide paths embrace the same philosophy, it’s important that plans ask the managers what the glide path was developed to do, when, and why. Ultimately, understanding the risks and goals the target date manager is trying to address is the key to determining if the strategy aligns with the needs of participants.

Another hot topic in the industry is active versus passive management. Which is more appropriate for Target Date Funds?

This question comes up quite frequently. The reality is that there’s no such thing as a truly passive target date fund. A fund manager might implement an investment strategy with passive vehicles, but developing the strategy is always an active decision. Deciding how aggressive the glide path should be, for instance. Or what asset classes to include, or even how much should be allocated to each asset class. These are all active decisions. Even choosing to invest in active or passive vehicles is an active decision. It also brings up some fundamental questions about active management: What does it mean to be an active manager? Does it mean fundamental active managers? Quant managers? High tracking error managers? Low tracking error managers? It could mean different alpha targets or different risk budgets. So it’s never black and white. Fiduciaries need to understand what “active” and “passive” mean in the context of a target date fund then determine what makes most sense for them.

How do the Prudential Day One Funds manage risk?

Prudential Day One Funds were built to solve for specific risks investors face at different points in their lives — from the time they begin working in their early 20s until they rely on the income from their portfolios during retirement, in some cases well into their 90s. So these are very long-term investments — 60, 70 years, maybe more. That’s why we take a highly strategic long-term view and base short-term market expectations within the context of that long-term view. Long-term outcomes are a far greater priority for us than making short-term moves in order to add incremental alpha. This gives us more consistent outcomes and a higher probability of success for participants over their lifetimes.

That’s a different kind of fund management — beyond the accumulation phase and into the drawdown of income.

That’s correct. We view a person’s lifespan not as either accumulating assets or drawing income, but as one continuous investment experience that evolves over time. Many people leave their assets in the same portfolios, particularly if they know the portfolios were designed to last through retirement. So we’ve designed our Day One Funds as a through series to help meet participants’ needs leading up to, as well as through, retirement. We think it’s more prudent to have a target date series that’s focused on participants well into their 90s, rather than only until the day they retire, so we built the Prudential Day One Funds for people to draw income through age 95. This creates a series based on a unique philosophy.

Does that philosophy mean Day One Funds will invest in Alternative asset classes as well?

We’ve found non-traditional asset classes can provide great benefits. They can be fantastic diversifiers as well as fantastic hedges against inflation for retirees. So we invest in commodities. We invest in REITs. We invest in private real estate. But Alternatives are not typically the cheapest investments. So we weigh the benefits against the costs for each investment we consider, and package Alternative investments with both active and passive investments so we can provide the benefits while holding fees down.

Fees always seem to be a concern. Why the focus on cost?

Fees are easy for plan participants to understand. They can easily see that average target date fees are 70 or 75 basis points. If the fees in their series are 85 or 90 basis points, that can be a problem. Some plans choose to offer an all-passive series because it’s cheaper. But plan sponsors are fiduciaries and have responsibilities beyond simply holding costs down. If going to an all-passive offering means participants don’t have the ability to meet their long-term needs that can be a bigger problem than higher fees.

How do you balance cost and fiduciary responsibility, so that a plan meets participants’ needs without being overly expensive?

Costs have made plan sponsors think long and hard about what they believe when it comes to active and passive investing. That’s why we’re starting to see more hybrid approaches in target date funds that blend both active and passive vehicles. If a passive fund perfectly replicates a benchmark, it will always deliver negative alpha after fees. But if you use some active management we have the potential to generate a return over and above the fees, and generate some additional alpha on top. And that’s exactly how the Prudential Day One Funds were constructed.

Can you sum up what differentiates Prudential Day One Funds?

Day One Funds are designed to address the evolving risks of participants over their life span — from those beginning their careers to people nearing retirement to retirees who need to make sure their assets will last the rest of their lives. That approach is evident in how much equity risk we take across different points in our glide path, informed by the savings rates, salaries, and employer contributions of over 850,000 participants on our recordkeeping platform. We also choose asset classes to help achieve a better outcome, from mainstream asset classes to Alternatives like commodities, REITs, and private real estate. Finally, we combine active management with passive management to help strengthen results while keeping costs down. For participants, that means Day One Funds can provide a highly strategic, and well thought out investing approach they can depend on for decades to come.


RISKS: Investing involves risk. Some investments are riskier than others. The investment return and principal value will fluctuate, and shares, when sold, may be worth more or less than the original cost, and it is possible to lose money. Past performance does not guarantee future results. Asset allocation and diversification do not assure a profit or protect against loss in declining markets.

Prudential Day One Funds are offered in the following structures: (i) separate accounts available under group variable annuity contracts issued by Prudential Retirement Insurance and Annuity Company (PRIAC), Hartford, CT, a Prudential Financial company, and (ii) collective investment trust funds established by Prudential Trust Company, as trustee, a Pennsylvania Banking Corporation located in Scranton, PA and a Prudential Financial company. Each of PRIAC and Prudential Trust Company is solely responsible for its own contractual obligations and financial condition. Offers of the collective investment trust funds may only be made by sales offices of Prudential Trust Company. A target date fund should not be selected based solely on age or retirement date, is not a guaranteed investment and the stated asset allocation may be subject to change. As with all investments, there are a number of factors and risks to consider in selecting a target date fund. In addition to anticipated retirement date, relevant factors for Fund selection may include age, risk tolerance, other investments owned, and planned withdrawals. In addition, participants should carefully consider the investment objectives, risks, charges and expenses of any Fund before investing. It is possible to lose money in a Fund—including near or following retirement or the target date—and there is no guarantee that the Funds will provide adequate retirement income. Investments in the Funds are not deposits or obligations of any bank and are not insured or guaranteed by the FDIC, or any other governmental agency or instrumentality. The Day One Funds, as insurance separate accounts or collective investment trusts, are investment vehicles available only to qualified retirement plans, such as 401(k) plans and government plans, and their participants. Unlike mutual funds, the Day One Funds are exempt from Securities and Exchange Commission registration under both the Securities Act of 1933 and the Investment Company Act of 1940, but are subject to oversight by state banking or insurance regulators, as applicable. Therefore participants are generally not entitled to the protections of the federal securities laws.

© 2016 Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo, the Rock symbol and Bring Your Challenges are service marks of Prudential Financial, Inc., and its related entities, registered in many jurisdictions worldwide.


[1] “Retirement Markets 2014: Sizing Opportunities in Private and Public Retirement Plans,” The Cerulli Report, November 2014.

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