Glide path convergence signals trouble for TDF strategies, argues NFP’s Fergus Meldrum
Each month at BPM, we offer a slate of articles and content pieces that go deep on a particular topic. This month, we're exploring the assets and retirement solutions that make up defined contribution (DC) plans.
Target date funds (TDFs) now hold the dominant share of assets flowing into DC plans, but that popularity may be creating a false sense of security among plan sponsors, particularly those who set a default option years ago and haven't looked back since.
Fergus Meldrum, vice president of business development and investment strategies at NFP Canada, has watched the TDF market evolve considerably, and while he sees genuine progress at the large end of the market, he believes the small and mid-market are treating their TDF selection as a one-time decision rather than an ongoing responsibility.
“You should work with a good advisor and every couple of years bring some other options to the table and compare what you have today versus what's out there in the market. It’s good governance,” said Meldrum. “Certainly, if you know your default investment choice is a target date fund, it makes good sense to do that. But you’ve got to be working with an advisor that understands the market and understands that not all target date funds are equal.”
Larger plan sponsors are doing their homework as many have approached NFP to pressure-test whether their current target date fund still holds up against a growing field of competitors and new market entrants, Meldrum noted. Consequently, two or three managers have moved their glide paths up in recent years, adding more equity exposure throughout the member journey, a shift Meldrum attributes to performance pressure during a strong run in markets.
Still, few have actually made a switch, he noted.
"You can imagine it's a pretty big decision when 80 per cent of the assets are now flowing to these products to choose to move away from one manager to another," he said.
TDFs have been a dominant default investment option, Meldrum explains, because historically, plan sponsors defaulted members into money market or conservative asset allocation funds and members stayed put. Some sat in those defaults for two decades, earning returns of a couple percent a year. TDFs addressed this by aligning the portfolio to where someone actually is in their working life, with younger members carrying more growth exposure and the mix gradually shifting toward capital preservation as retirement approaches.
Assessing TDF performance is harder than it looks, Meldrum suggests, because each manager uses its own custom benchmark, unlike Canadian equity or US equity funds, which can be measured against a universal index.
That opacity means plan sponsors can't simply line up funds and compare raw numbers but rather, the evaluation needs to be multi-layered. Meldrum acknowledged quartile rankings show how a fund stacks up against peers in the same category so the glide path itself deserves scrutiny to determine if it matches the plan's needs and philosophy. Fee analysis matters, as does the active-versus-passive split within the fund.
At NFP, the practice is to run annual comparisons between the plan's current target date fund and alternatives available from the same vendor, flagging any concerns that emerge, Meldrum noted.
Yet, the critical difference from what came before is that the product doesn't stand still, Meldrum explains, because “the product evolves, it changes with you as you get older,” he said.
“Unlike a lot of the static default investments that were available a number of years ago, you've got a product here that is going to align with that person based on who they are today but is going to change with the member as they get older. So, it removes that concern around ‘Am I still in the right investment mix?’ because of the fact that the product evolves.”
Should an employee get a change in salary, Meldrum underscored how it doesn’t warrant switching TDFs as he believes it takes a meaningful shift in life circumstances to justify revisiting the fund a DC member is in.
The most common factor is expecting to work past 65, particularly since most TDFs are built around that retirement age, someone planning to work longer might consider moving to a later vintage.Less discussed, but equally worth flagging, is the use of group RRSPs for shorter-term goals, Meldrum noted.
Evaluating whether a target date fund's glide path fits a particular plan starts with understanding how managers build it in the first place, emphasized Meldrum. Investment managers run detailed analysis on asset allocation across different age bands, modelling expected savings levels for the average Canadian, and estimating drawdown rates in retirement.
That research is core to TDFs and Meldrum believes plan sponsors should take the time to understand them. Still, manager research only goes so far because it also matters whether a specific plan's design is richer or leaner than average, whether employees are saving more than typical, or whether account balances skew higher or lower. Those factors should inform how aggressively a glide path needs to work, underscored Meldrum.
Yet, what concerns him more is what's been happening across the industry.
“We are finding more and more that the glide paths are starting to look a little more similar than they did in the past,” noted Meldrum. “So you hope that it's not just plan sponsors looking at absolute returns thinking they’re going to go with the fund that has the highest return because the devils in the details. Is the glide path more aggressive? Is it more conservative? Is it a to retirement or a through retirement? You really need to work with companies on figuring out what their philosophy is, whether it’s passive versus active as well as the fee that's being charged by the manager.”
“You've got to take all that into consideration versus just simply picking the funds, the target day funds with the best returns and especially with what's happened in the market over the last few years,” added Meldrum.
