Choosing a target date strategy: Weighing off-the-shelf vs. recordkeeping platform modelsContributors Dan Notto, Daniel Oldroyd
- Financial advisors who consider the recordkeeping platform model for their clients’ target date strategies may underestimate the challenges the model presents. Substantial resources and expertise are required to evaluate the model’s available glide paths and asset allocation, and to select underlying investment managers. All these critical elements must meet fiduciary standards.
- Both off-the-shelf strategies and recordkeeping platform models offer professionally managed, well-diversified multi-asset solutions for a wide range of defined contribution (DC) plans and participants. They can be highly effective tools to help plan participants reach their retirement goals.
- An off-the-shelf strategy, the traditional target date approach, may present the better choice. An off-the-shelf strategy can provide tactical asset allocation and allow for portability, but the models are not portable and often do not offer tactical asset allocation. In addition, the underlying investments in the models are typically limited to those on the plan’s menu; this usually precludes the use of extended asset classes. Finally, it can be much more difficult to measure and communicate performance in a platform model when compared with an off-the-shelf strategy.
Financial advisors and plan sponsors face complex choices when they select target date strategies for defined contribution plans. The first choice is foundational and in some ways the most important: an off-the-shelf or a custom target date strategy?
In an off-the-shelf target date strategy, the traditional approach, an investment manager sets overall asset allocation, establishes the glide path (the change in asset allocation as the target date fund, or TDF, gets closer to its end date), selects underlying managers and, in some cases, deploys tactical asset allocation, making measured, opportunistic shifts in asset weightings. With a few exceptions, off-the-shelf target date solutions are also known as proprietary strategies because they include the proprietary funds of the target date provider.
Although there are many varieties of custom target date strategies, they generally fall into one of two categories: complete customization or the recordkeeping platform model. For the completely customized approach, a plan sponsor hires a portfolio management team to design and manage a plan’s glide path. The plan sponsor either selects the underlying managers itself or outsources the decision. The recordkeeper or custodian handles cash flows and portfolio rebalancing. (For further analysis of complete customization, see our white paper "Custom or off-the-shelf target date strategies?" ) In the typical scenario for a recordkeeping platform model, a plan sponsor—usually following the lead of a financial advisor—selects a custom target date glide path from among the choices on a recordkeeping platform, which may range from conservative to aggressive in risk profile. The advisor evaluates overall asset allocation (usually set by the recordkeeper or a third-party entity) to determine which glide path model may be most suitable for the plan; the advisor then selects underlying managers, typically drawing on the manager roster in a plan’s existing DC lineup.
In the following pages, we examine the elements of a target date strategy and consider the choice between off-the-shelf and recordkeeping platform models (EXHIBIT 1). Financial advisors, we conclude, may not appreciate how much decision-making and responsibility they take on when they recommend a recordkeeping platform model—and thus may underestimate the challenges they could face.
Financial advisors must assess a wide range of issues in selecting a target date strategy
EXHIBIT 1: KEY CHARACTERISTICS OF OFF-THE-SHELF VS. RECORDKEEPING PLATFORM MODELS
TARGET DATE FUNDS: Target date funds are funds with the target date being the approximate date when investors plan to start withdrawing their money. Generally, the asset allocation of each fund will change on an annual basis with the asset allocation becoming more conservative as the fund nears the target retirement date. The principal value of the fund(s) is not guaranteed at any time, including at the target date.