DALBAR Due Diligence: Trust, but Verify

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1 2013 September 28, 2013 The (TDF Facts) is an annual compilation of of key information about these funds that are necessary to understand and evaluate these investment vehicles. TDF Facts is intended for use by advisors and fiduciaries to carry out their duty to prudently select and monitor investments. TDF Facts provides a context for establishing reasonable expectations in the most important areas of evaluation of performance. Selection and monitoring of Target Date Funds require complexities that extend beyond the traditional investment evaluation. These measures are presented in the TDF Facts: Performance in market conditions that reflect the ability to preserve capital as well as the ability to participate in appreciating markets. Reliability of performance in varying market conditions for each target year. Expenses for each target year in relation to the service level provided. TDF Facts is best used in conjunction with the TDF Rating Methodology. Contents Performance in Up and Down s... 2 Best and Worst Results... 2 Top Ten Target Date Fund Families... 3 Target Date Fund Reliability... 4 Most and Least Reliable Funds... 4 Top Ten Most Reliable Fund Families... 5 Target Date Fund Fees & Expenses... 6 Advisor Expectations... 6 Lowest and Highest Fees & Expenses... 8 Target Benchmarks... 9 Recent Target Date Strategy Changes Target Date Fund Universe DALBAR, Inc. Federal Reserve Plaza Boston, MA Phone: Atlantic Avenue Fax:

2 Performance in Up and Down s There are two primary goals of all Target Date Funds: 1. Preserve capital during periods of decline 2. Participate in the appreciation during periods of rising markets The first TDF Facts measure is an assessment of how well Target Date funds have achieved these goals. This is done by presenting how well the best performing Target Date Fund compares to the worst in the most severe period of decline (2009), referred to as Up as well as the strongest period of rising markets (2008), referred to as Down. The information is provided separately for each Target as well as an average across all Target s. The Gap represents the maximum advantage possible if the best performer is selected. All amounts shown are total return percentages after expenses. Best and Worst Results Target s Avg Up (2009) Best Worst Gap Down (2008) Best Worst Gap

3 Top Ten Target Date Fund Families Target date funds are of the used in families that represent as set of separate Target s, all offered by a single investment provider. Components of each fund (sleeves) may be managed by one or more manager. Only fund families in existence for all time periods evaluated are included. Fund families that were not in existence for the first critical period (2008) or ceased to operate before the most recent full year () are not considered to have a sufficient record to be included here. The following table shows the best performing fund families, after weighing: The relative performance (Rank) among 171 peers in the most critical periods: o Up (2009) o Down (2008) o Turbulent (2011) o Recent () The reliability of performance measured on a scale of 0 to 100 and is based on the deviation in relative performance from year to year. Reliability reflects the statistical probability that the fund family will continue to have similar performance relative to its peers in the future. Rank Target Date Family Up Rank among 171 Fund Families Based on Total Return (after expenses) Down Turbulent Recent Critical Avg Reliability (0 100) 1 MFS Lifetime R % 2 The Hartford Target Retirement R % 3 American Funds Trgt Date Ret R % 4 JPMorgan SmartRetirementr Instl % 5 MainStay Retirement I % 6 BlackRock LifePath Active K % 7 T. Rowe Price Retirement % 8 GuideStone Funds MyDestination GS % 9 Invesco Balanced-Risk Retire R % 10 MassMutual RetireSMART S % 3

4 Target Date Fund Reliability In selecting an investment the past performance provides insights into capabilities but the history by itself is not a reliable predictor of the future for two principal reasons: 1. Past performance may have been achieved by accident and not skill, and 2. Future market conditions may differ from the past periods The Target Date Fund Reliability provides a measure of statistical probability that limits the potential error of evaluations based on past performance. The error due to accidental performance is reduced by measuring the deviation in performance over several critical periods. The likelihood of achieving consistent performance in the most significant Up, Down and Turbulent is highly improbable. The addition of the most recent full year further lowers the likelihood that the past results were due to an aberration or accident. The error due to future market differences is reduced by evaluating performance in relation to peers and not the actual return produced by the fund. This relative performance or Rank is independent of whether the markets are rising, falling or highly volatile. Most and Least Reliable Funds Target s Avg Reliability of Relative Performance Most 81% 75% 82% 84% 81% 80% 83% 79% 71% 73% 72% 90% 79% Least 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% Gap 61% 55% 62% 64% 61% 60% 63% 59% 51% 53% 52% 70% 59% 4

5 Top Ten Most Reliable Fund Families Rank Target Date Family Up Rank among 171 Fund Families Based on Total Return (after expenses) Down Turbulent Recent Critical Avg Reliability (0 100) 1 BlackRock LifePath Active R % 2 DWS LifeCompass S % 3 The Hartford Target Retirement R % 4 MFS Lifetime R % 5 American Funds Trgt Date Ret R % 6 Fidelity Freedom % 7 MainStay Retirement R % 8 GuideStone Funds MyDestination GS % 9 ING Solution Portfolio T % 10 Russell LifePoints Strategy R % 5

6 Target Date Fund Fees & Expenses Fees and expenses and front end loads compensate or reimburse investment managers, advisors and others who enable investors to access the investment funds. These funds are available without advisor services, with limited advisor services or a full array of services. Advisor Expectations Prudence and regulations require that plan fiduciaries assume certain responsibilities that protect employees and their retirement assets. In many cases, the tasks necessary to carry out these responsibilities can be delegated to an advisor who is compensated by fees and expenses paid by the plan. In these cases, the extent of advisor support should be in reasonable proportion to the fess and expenses. Fees and expenses are put into four categories that reflect the level of advisor support that can reasonably be expected. No Advisor : No advisor fees are charged. Limited Advisor : Advisor fees are.25% or less. Full Advisor : Advisor fees are more than.25%. Front End Load : Applies when investments apply a sales charge for new investments. It should be noted that tasks that are not performed by the advisor remains the responsibility of the plan fiduciary. The plan fiduciary must perform these tasks or hire an expert to perform them. Required Tasks Define the plan s investment-related goals and objectives Prepare and maintain the plan s Investment Policy Statement ( IPS ) Reasonable Expectations from Advisors No Advisor Limited Advisor Full Advisor Front End Load No No No No No No Indentify asset classes appropriate for plan s portfolios No Conduct due diligence for plan investment options No No No No Choose investments and create portfolios according to the terms of the IPS No No No No Develop and maintain model portfolios No No No Construct QDIA investment alternatives No No 6

7 Required Tasks Monitor investment options and prepare periodic investment reports Periodically report investment decisions made to plan sponsor and Named Fiduciary Reasonable Expectations from Advisors No Advisor Limited Advisor Full Advisor Front End Load No No No No No No Conduct an initial fiduciary assessment No No No No Oversee plan administration activities No No No Support for DOL and IRS audits No No No Design rules for assigning participants to QDIAs No No Place participants in appropriate investments No No No Assist participants in selecting investments No No No Provide education to employees No Control and account for the plan s investment expenses No No No No Provide disclosure of estimated fees and services Evaluate reasonableness of fees and expenses in relation to the nature and quality of services rendered Periodically report fiduciary decisions made to plan sponsor and Named Fiduciary No No No No No No No No Select, hire and monitor other service providers No No No No Review plan s success in meeting participants needs and retirement goals and make recommendations for changes No No No 7

8 Lowest and Highest Fees & Expenses The fees and expenses for each level of services vary greatly as shown in the table below. Target s Avg Net Expenses No Advisor Low High Gap Net Expenses Limited Advisor Low High Gap Net Expenses Full Advisor Low High Gap Front End Load Low High Gap

9 Target Benchmarks The results of target date funds are compared to two references: All Funds for a Target : A comparison is made to all target date funds with the same target year that existed in the period(s) being evaluated (Qualified Funds). Balanced Benchmark: Funds that identify themselves as moderately balanced in their name are used for these benchmarks. Such funds include those with a static allocation %, others with limits on allocations and those with great flexibility to change allocations. Regardless of the fund s actual allocation, investors associate these funds with moderation. Moderate funds are considered to be the best reference, since their goal puts equal emphasis on capital preservation and appreciation. The tests determine the allocator s ability to preserve capital and capture appreciation in an up market (2009), a down market (2008), a turbulent market (2011), and a recent market (). Only funds that were in full operation during these periods qualify for the results ratings. The blend of capital preservation and appreciation varies based on the proximity of the target date of each fund. Recent and past target dates are designed to have more conservative allocations and target dates that are far in the future have more aggressive allocations. As a result, recent and past target dates should produce better returns than the normal allocation in Down Markets but underperform in Up Markets. Conversely, allocations with distant target dates should outperform the normal allocation in Up Markets but underperform in Down Markets. The following table illustrates this expected variation in performance, using moderately balanced allocation as the midpoint of the allocation range (norm). The target dates selected are for illustrative purposes only and are not intended to represent the universe of available target date investments. Expected Performance Quartile Rank In Up Markets In Down Markets First Best Second Midpoint of Allocation Range (Norm) Moderately Balanced Allocation Third Fourth Worst

10 Recent Target Date Strategy Changes Since the start of the critical test period (2008) various target date funds have made material changes to their investment strategies. The most significant changes are noted here to facilitate evaluation if one of these changed strategies are involved. Date of Change July 26, 2011 August 1, 2011 December 7, 2011 March 14, March 14, April 19, June 14, June 18, June 26, Target Date Fund, Family or Manager Vanguard Target Retirement Trust MassMutual RetireSMART Fidelity Investments Freedom Funds Invesco Balanced- Risk Retirement Funds PIMCO RealRetirement John Hancock J.P. Morgan Investment Management Columbia Management Retirement Plus AllianceBernstein s Lifetime Income Strategy Description of Change Collective investment trust version of existing target-date fund to better compete on price in the large and mega retirement plan markets. Changes include the reduction of expense ratios for target-date fund series, the launch of a target-risk series in a mutual fund structure and the rebranding of both series, which will now be known as the RetireSmart mutual funds. Shift the asset allocation of target-date funds to give its portfolio managers greater ability to gain more focused exposure to certain asset classes. As part of the change, the firm s Freedom Funds will add three brand-new Fidelity Series funds to the underlying mix of funds. Those include the Real Estate Equity Fund, Floating Rate High Income Fund and Real Estate Income Fund. Use of non-traditional asset classes and complex strategies. Invesco uses exchange-traded futures and some swaps on futures to invest in commodities as well as derivatives to trade in six global equity markets and sovereign bond markets, including Australia, Japan and Germany. Pimco uses derivatives in its target-date funds to hedge against inflation, credit risks and currency dislocations by buying options contracts, futures or swaps. Renamed target-date fund series in order to draw a clearer distinction between funds that are managed to and through retirement. The Retirement Living Portfolios will be called Retirement Living Through, and the Retirement Choices Portfolios will be the new Retirement Choices At series. Expanding target-date fund lineup with a new series that blends active and passive underlying investments as well as funds from unaffiliated managers. The new series, the JPMorgan SmartRetirement Blend Funds, uses a to approach and includes funds with maturity dates from 2015 to 2055 as well as an income fund. Liquidating Retirement Plus series, comprising eight funds. A new retirement plan product that combines the simplicity of a target-date fund with the lifetime income guarantees available through a traditional defined benefit plan. 10

11 Date of Change July 20, August 1, November 2, November 2, February 26, 2013 April 1, 2013 Target Date Fund, Family or Manager PNC Funds American Independence Funds NestEgg funds Franklin Templeton MFS Lifetime funds Invesco Balanced- Risk Retirement Funds Franklin Templeton Fund Allocator Series Description of Change Utilize a highly flexible mix of underlying equities, fixed income and nontraditional assets, such as commodities and real estate. Such lowcorrelation investments can account for up to 30% of the portfolio at a given time, even after the target date. Liquidation of the NestEgg funds. Gives asset allocation fund managers of the target-date and target-risk fund series the flexibility to double allocations to ETFs. Additionally, money market funds are being eliminated from the Conservative, Moderate and Growth Allocation funds. Added five funds to itthes target-date suite. The new funds have maturity dates of 2015, 2025, 2035, 2045 and They bring the series to a total of 11, with dates from 2010 to Added a new aggressive fund that employs more use of derivatives to its target-date fund glide path. The new fund, which is available only as an underlying investment in the target-date suite, uses a 12% long-term risk target. By comparison, the existing fund uses an 8% long-term risk target. The new aggressive fund uses the same portfolio managers, strategies and investment objectives as the existing fund, though the new fund has a higher use of derivatives and a greater potential for volatility. Portfolio managers will no longer be required to make tactical allocations to cash, though they retain the option of doing so at their discretion. May 3, 2013 American Century Replacing the Livestrong brand for its target-date funds with One Choice, distancing itself from disgraced cyclist Lance Armstrong while continuing to support the cancer research foundation he founded. May 23, 2013 T. Rowe Price Introduces a new line of target-date funds that feature a more conservative glide path. The new funds glide path differs from that of the existing funds by as much as 14.5 percentage points in equities at 10 years from the target date. The new funds are anticipated to invest 42.5% in equities at the target date, versus 55% for the existing product line. June 14, 2013 Vanguard Target Retirement Funds The Vanguard Short-Term Inflation-Protected Securities Index Fund, launched in October, replaced an actively managed broad-market TIPS fund used in the suite, and a cash allocation was also removed, erasing the last vestiges of active management. The change has allowed the suite to use index strategies exclusively. 11

12 Date of Change August 7, 2013 August 20, 2013 September 27, 2013 Target Date Fund, Family or Manager Fidelity Investments Freedom Funds Franklin Templeton LifeSmart Target Date Funds Fidelity Investments Freedom Funds Description of Change Changes to the investment objectives, benchmarks and names of some of the underlying investments within its target-date lineup. Fidelity Series Mega Cap and Advisor Series Mega Cap will be renamed the Fidelity Series Growth & Income and Fidelity Advisor Series Growth & Income. The funds have also been given a new benchmark: The S&P 500 Index will replace the Russell Top 200 Index. Added four funds, incorporating "to retirement" targets at five-year intervals. The new funds are pegged to the retirement target years of 2020, 2030, 2040 and 2050, complementing the existing funds for 2015, 2025, 2035 and Revamp of target-date funds glide paths by increasing equity allocations at the expense of short-term debt, among other asset classes. The new allocations reflect Fidelity s analysis of research on investor behavior and demographics, including the trend of delayed retirements, as well as on secular-based capital markets assumptions and new assessments of investors ability and tolerance for withstanding portfolio volatility or losses. The new allocations will result in a 43% domestic equity target for the Freedom 2020, from 39% currently, while the international equity target climbs from 14% to 18%, bond funds fall from 39% to 32%, and short-term funds from 8% to 7%. 12

13 Target Date Fund Universe Ratings are performed for Target Date funds that existed during Critical Periods that tested the ability of the funds to meet their primary goals of capital preservation and market appreciation. In order to be rated, the fund must have been in existence for the full calendar year of each Critical Period. The Critical Periods are: 2009: Up year that tested capital appreciation 2008: Down year that tested capital preservation 2011: Turbulent year in which both capital preservation and appreciation were tested : Most recent year that establishes that the fund is still viable The total universe of Target Date Funds is xxx, of which yyy qualify for ratings. 13