The essential Guide To TarGeT date Funds

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1 The Essential Guide to Target Date FundS

2 ALL TARGET DATE FUNDS ARE NOT CREATED EQUAL Target date funds are a revolutionary idea: A single investment that evolves over time according to the changing needs of participants. The power of that idea can be seen in their rapid growth and status as a Qualified Default Investment Alternative. For Plan Sponsor and Financial Professional Use Only. Not to be shown or distributed to participants

3 But as plan sponsors embraced target date funds, they often didn t recognize how dramatically funds even those sharing the same target date can differ. Nor did they recognize the significant impact those differences could have on whether participants can reach their retirement savings goals. So, yes, all target date funds are not created equal and with the proliferation of funds and customization options, the differences are more profound than ever. But that s good. It means you have choices, provided you understand the differences and can use them to your advantage. Choice, however, brings risk, leaving you with an increased fiduciary responsibility to make sure the fund you choose aligns with your plan s goals and objectives. This guide is designed to help you understand the bottom line on target date funds. There are many approaches to delivering retirement outcomes. What s essential is that you understand what you re getting and whether or not it delivers what you want to your participants.

4 1 Know Your Destination Your objective sets the course Imagine a 45-year-old participant. She s in midcareer and has her 401(k) assets in a 2035 target date fund. Now imagine explaining to her what she should expect as the calendar zeros in on her target year. Would she be more concerned with protecting what she s earned, or should she still be focused on maximizing her savings through investing? Or is it somewhere in between? As defined contribution professionals, we think of retirement in terms of economic forecasts, market access, and risk. But for participants, it is much more emotional. Your target date fund s objective will have a major impact on everything from how secure participants feel as they approach retirement, to how much they can spend once they get there. THE BOTTOM LINE Think about what you want for your participants and define your objective explicitly. Do you want less risk exposure (especially nearing retirement) to preserve savings? Or is your goal to help them maximize every dollar invested? Capture your plan s objective in the Investment Policy Statement and work with your target date provider to ensure your fund matches your vision.

5 Different Objectives, Different Results If every target date fund with the same target year had the same objective, their performance would be similar. But as the chart shows, that s not the case. The spread between the highest and lowest returns reaching its peak in 2008 and 2009 is clear evidence that not all target date funds are created equal. Principal value is not guaranteed at any time including the target date target date fund return spreads 50% ANUAL RETURN YEAR/NUMBER OF FUNDS Source: Morningstar.

6 2 Planning the Journey The glidepath manages the ride Consider our 45-year-old participant. At 25, she had little invested in her 401(k) and had many years ahead to absorb market volatility. At 65, she will have accumulated the bulk of her savings and will soon begin to draw on that savings for income. Your target date fund has to meet your vision for her at every stage of her career. The target date in the name of the fund is the approximate date an investor plans to start withdrawing money. The target date fund s glidepath maps the mix of asset classes that will bring her from the start of her career into retirement. It sets the equity percentage at the beginning and the landing point at the end. It sets the rate at which fixed income and inflation-fighting asset classes replace equities as the fund ages to maturity. Your glidepath needs to achieve your fund objective and shape your participants experience along the way. THE BOTTOM LINE There are three key decisions when building the glidepath: the equity percentage for the longest dated funds, the final equity landing point and the rate at which the equity percentage declines. Work with your provider to understand how the glidepath sets out to achieve your plan s objective and what your participants can expect at each stage of their careers.

7 Putting the Objective into Action Target date funds need to manage market risk, inflation risk and longevity risk across decades of retirement savings and spending. But different funds take different paths to their target year. Below are glidepath risk levels for several leading funds. It is important to understand that different glidepaths can have very different risk levels at the same point in the journey. same target year, different glidepaths 14% 12 EXPECTED ANNUALIZED RISK (%) Source: BlackRock YEARS TO RETIREMENT RETIREMENT

8 Winding Down The Glidepath As our participant moves throughout her career, her human capital that is, her potential future earnings will wind down, replaced by her accumulated savings. That savings will have to support decades of retirement spending. How does the glidepath take this transition into account? All target date funds reduce risk exposure as participants move through their careers. As the illustration on the previous page makes clear, however, they do so at very different rates. Risk exposure in late career and into retirement is one of the most important areas where differences in objectives can be seen, with objectives centered around supporting retirement savings generally having lower equity exposure than those seeking to maximize investment. An even more critical question one increasingly at the center of today s retirement conversation is what your plan s role should be in turning savings into food, shelter and living expenses in retirement. A glidepath designed to meet a sustainable withdrawal rate of, for example, 4 to 5% annual real drawdown over thirty years will need a balance of growth exposure, diversification and inflation protection through real assets. Your participants appetite for volatility will also need to be considered when choosing a glidepath.

9 Protecting Retirement Savings A higher level of equity exposure near the target date can result in negative surprises that undermine retirement savings. For example, many 2010-dated funds experienced dramatic losses during the financial crisis because they held high levels of equities at or near the retirement target date a time when participants needed to protect their savings the most. Negative surprises: 2010 Target Date Fund Returns ( ) 0% -2 2-YEAR ANNUALIZED RETURN % 30% 40% 50% 60% 70% EQUITY ALLOCATION Source: Morningstar Target Date Fund Return

10 3 Check the Engine Asset allocation Drives your target date fund Once upon a time, the opportunity set of asset classes available to participants was relatively small. Over the last decade, however, asset classes previously only available to sophisticated institutional investors have become accessible to individuals. These new choices require expertise and perspective to determine which are investable, additive, and can be implemented in a cost-effective manner to improve outcomes. Take a deep look inside the fund s underlying building blocks to determine the depth of diversification they provide and how the pieces, including equities, fixed income and real assets combine into an efficient, powerful engine driving toward your objective. THE BOTTOM LINE Effective asset allocation requires a robust process that identifies the right building blocks to drive performance over a long time horizon and produce consistent results. You also need to understand how all the parts of the asset allocation engine work together.

11 Diversification: Is More Always Better? Does adding a new asset class always improve diversification? Not necessarily. As the chart shows, the improvement provided by increasing diversification tends to diminish at a certain point. A carefully constructed asset allocation takes into account the complexity, expense and impact on performance that each new asset class brings. limits of diversification 50% 40 TOTAL PORTFOLIO VARIANCE SECURITIES IN PORTFOLIO Source: Elton & Gruber Expected Portfolio Variance For Illustration Only

12 4 Fine-Tune the Ride Effective Implementation Can Improve Performance Your target date fund objective, glidepath and asset allocation are the most important elements in driving investment outcomes. But the way you deliver target date funds to your participants can also have an impact on participants savings and outcomes over time. Index or Active Management The decision whether to use index or active asset class management depends, in part, on your investment philosophy. Do you have a conviction that active management can generate better-than-market returns over time, or do you believe that capturing the market as efficiently as possible is the best way to generate long-term returns? Or, do you believe a mixture of active and index management makes the most sense? THE BOTTOM LINE Finally, choose a guide who knows the way. An important part of the target date selection process is deciding who will help navigate the path for your participants retirement journey. Target date fund managers differ widely in their experience, capabilities, and resources, so it s key to select a team that understands your needs and objectives, and can proactively bring perspectives and expertise to the table that you cannot find in-house.

13 Strategic or Tactical Glidepaths are typically based on long-term strategic economic forecasts. Allowing adjustments to the glidepath to capture nearterm market movements can add returns, but can introduce additional risk. If you are exploring tactical glidepath or asset class management it is critical to understand how, why and when adjustments can be made and whether the approach makes sense for your objective. Collective Trust Funds or Mutual Funds Collective trust funds (CTFs) leverage economies of scale and can reduce expenses for DC plans of sufficient size. CTF agreements may also permit a wider range of instruments and strategies than some mutual funds. On the other hand, mutual funds offer greater transparency that makes them the preferred choice for many larger plans. Special Investment or Participant Needs Unique participant demographics or specific investment beliefs may be addressed through customization, or through the addition of specialized asset classes. Guaranteed retirement income can also be generated through specialized solutions.

14 IT S A NEW WORLD OF INVESTING With the retirement futures of so many participants in your hands, selecting the right target date fund is now more important than ever. You need to rely on intelligent solutions that are designed to help participants navigate today s uncertain world and can adapt to continuing changes in the markets. Armed with the right questions, you can sift through the universe of target date funds and find the right choice for your participants. To learn more about how to navigate the new wo

15 Who Is BlackRock DC? Many of the world s largest DC plans trust BlackRock with their participants retirement futures. As an independent, global defined contribution investment-only provider, BlackRock DC provides a breadth of capabilities and depth of knowledge across asset management, plan design, client engagement and participant communications. Our dedicated DC professionals work with plan sponsors, consultants and financial advisors to share the best thinking from across the globe for objective insights on the ever-evolving challenges of this new world. BlackRock aims to help you bring clarity to the most complex retirement plan objectives, so that together we can deliver the best possible outcome for participants. Key Facts Three decades of DC experience Invented the industry s first target date fund in 1993 Work with 50% of the top 200 US DC plans More than 80 dedicated DC professionals Fiduciary responsibility over every dollar invested through our plans rld of retirement, visit

16 All statements herein are qualified by, and any offer is made solely pursuant to, a final offering document and investment management agreement. No offer to purchase units in any fund will be accepted prior to receipt by the offeree of these documents and the completion of all appropriate documentation. The strategies referred to in this publication are among various investment strategies that are, or will be, managed by BlackRock as part of its investment management and fiduciary services. Investing involves risk, including possible loss of principal. Asset allocation models and diversification do not promise any level of performance or guarantee against loss of principal. BlackRock Institutional Trust Company, N.A., a national banking association operating as a limited purpose trust company, manages the investment strategies and other fiduciary services referred to in this publication and provides fiduciary and trust services to various institutional investors. Strategies maintained by BlackRock are not insured by the Federal Deposit Insurance Corporation and are not guaranteed by BlackRock or its affiliates. The information included in this publication has been taken from trade and other sources considered reliable. No representation is made that this information is complete and should not be relied upon as such. Any opinions expressed in this publication reflect our judgment at this date and are subject to change. No part of this publication may be reproduced in any manner without the prior written permission of BlackRock. This publication is not an offer to sell, nor an invitation to apply for any particular product or service. FOR MORE INFORMATION: For Plan Sponsor and Financial Professional Use Only. Not to be shown or distributed to participants 2012 BlackRock, Inc. All Rights Reserved. BLACKROCK, ishares, BLACKROCK SOLUTIONS and LIFEPATH are registered trademarks of BlackRock, Inc. All other trademarks are those of their respective owners. Lit. No. DC-TDFGUIDE-1012 DC / DC0026

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