The Gordon Asset Management Podcast

#18 - American Funds Target Date Fund update wsg/John Doyle, SVP & Retirement Strategist, American Funds

December 31, 2020 Gordon Asset Management, LLC Episode 17
The Gordon Asset Management Podcast
#18 - American Funds Target Date Fund update wsg/John Doyle, SVP & Retirement Strategist, American Funds
Show Notes Transcript

The Gordon Asset Management Podcast welcomes John Doyle, Senior Vice President & Retirement Strategist for Capital Group / American Funds to the show.  On the podcast we discuss the past, present, and future of Target Date Fund solutions, differentiators among TDF providers, and considerations for TDF suitability.  For more information about Capital Group / American Funds, please visit

Intro  0:01  
Welcome to the Gordon Asset Management podcast, a show for savers investors and entrepreneurs helping you to stay informed, invest wisely, and achieve the unimaginable. Now, on to the show.

Todd Zempel  0:20  
Welcome to another edition of the Gordon Asset Management podcast. This is Todd Zempel. And with me, I have Joe Gordon. Today, we have another very special guest edition of the podcast. Today, we would like to welcome john Doyle with Capital Group. JOHN, welcome to the show. 

John Doyle  0:39  
Thanks, Todd. Thanks for inviting me really appreciate it. Absolutely. 

Todd Zempel  0:43  
JOHN, before we get into, can you provide our listeners with a little background on you and where you came from and your role in Capital Group today? 

John Doyle  0:51  
Sure, I'd be happy to. So I am my official title is Senior Vice President and Senior retirement strategist for Capital Group and American funds. And I've been doing this or something similar for really over 30 years, mostly focused on all things related to employer retirement plans, how to make them work better, how to make them help participants, in terms of their planning and achieving better outcomes. I've been with Capital Group for seven years. Before that, I was with a number of other investment managers and retirement plan providers. And so over the years, a lot of what I've done has been built the development of educational programs, but also investment solutions. And you know, while the education programs continue to work and get better, probably the most impactful change that I've been involved in has been the acceptance of target date funds, and both as a viable solution and also as a default, really starting with the pension Protection Act. But that's been most of my background for the last 30 some years is focused on retirement plans, and solutions. 

Todd Zempel  2:04  
Perfect. Thank you. So you're really you've been a pioneer on the whole target date fund movement. Can you speak a little bit about that the history of target date funds in general and QDIA qualified default? solutions? 

John Doyle  2:20  
Yeah, great question. So target date funds were first developed in probably the early 90s. And I want to say somewhere between 92 and 94, there were they were they were introduced as an option for participants, that they could select them within a plan, they really didn't develop a lot of traction. At first, there were a couple of providers who were who were well known in the retirement space, and they made them available. And that's really all it was, it was an option within a plan that seemed to simplify the selection process for for participants. But you know, a lot of the messaging around investing in retirement plans was around diversification and not putting all your eggs in one basket. So at least at first, what we saw was, was participants who might, you know, not understand how best to use them. And either use multiple options or have a target date as one of many options that they selected. And at the same time, the plan sponsors were still very nervous about putting defaulting participants into anything that had any sort of risk associated with it, because they were concerned to a certain extent about their liability. So the real shift came in the mid 2000s, as the Department of Labor started to look at better solutions for participants as they were being moved into retirement plans where decisions were being made about retirement plans, and trying to move them away from the money market or stable value default, which really wasn't appropriate for somebody in their 20s or 30s. And the real traction for target date then started to build after the pension Protection Act in 2006. When the regulations changed, and the law basically stated as a safe harbor that you could use target date among others as what the new

QDIA a solution and QDIA stands for qualified default investment alternative. And it's basically a safe harbor that came through the pension Protection Act and then was defined by the Department of Labor that laid out what type of investments could be used as a default, and that included target date funds and included risk based funds and included balanced funds, and then managed accounts and other similar solutions and and the real driver behind that right regulation was to not default young workers into kind of what might be termed risk free, not quite. But but but to a certain extent. But we're we're long term returns were significantly lower. So I think that's really what started this movement, as you called it to target dates as being you know, first of all, in most plans and being the default. In most plans, I was looking at some numbers from from psca recently that I think 81% of plans use a target date as target date fund as their default. And then the balance is mostly either risk based or balanced.

Todd Zempel  5:43  
Right, and so with 80%, of plans offering target date funds, and I would venture to say somewhere in the neighborhood of 75 to 80% of all new dollars being invested in target date funds. Obviously, the selection of the target date fund in the 401k is vastly vastly important. So you have to consider things like fees, expenses, philosophy, the investment manager, etc, etc. When looking at various target date fund providers, what are the key things, the key differentiators in your mind amongst the different target date fund providers?

John Doyle  6:20  
So, you know, there's kind of high level and then there's under under the hood, types of differences. I think, probably the most common differentiated differentiators that people look at are either is that a two glide path or a through glide path, and I'll talk about that in a minute. Or is it is the target date fund made up of active building blocks or passive building blocks. And I use the term building blocks because those are the underlying investments that a target date fund invests, I think most people understand target date. And most target dates are a fund of funds where they're they're utilizing other investments, other funds within the target date fund itself. And, you know, the the difference between a active stock fund and a passive stock fund is pretty clear the passive stock fund investment index, well, there's really no such thing as a target, a passive target date index. So there's no such thing as a true passive target date, there are active decisions being made around what building blocks to use, and what asset allocation makes sense for that particular target date. 

So differentiation between active and passive and target dates is really around the building blocks, not necessarily around the fund itself. And then the two verses through differentiation, most, a lot of the target date funds, stop the change in asset allocation at age 65, while others continue to manage that manage the allocation beyond age 65. And let me explain a little bit what I mean by that with a target date fund when you're when you're younger. So the 2016, or even now, the 2065 fund, you're primarily invested in stocks, and that that percentage is reduced over time, until the glide path stops gliding. And that that means basically, it's reached its lowest allocation to equity, and its highest allocation to fixed income, many target date funds, stop it at at the target date. So, for example, the 2020 fund hit a static allocation in a two glide path in 2020. This year, great year that it was. Whereas the through glide path will continue to change that allocation, anywhere from five to 30 years American funds, we continue to manage it 30 years past the retirement date, or the date stated on the font, some don't go quite as far as 30 years. So that's, that's the high level differentiation that I think most people look at and understand right off the top of their head. But I think what we found is that, that when you look at how the building blocks are managed, and how that glide path is managed and executed, you start to see some significant differences, you start to see where, you know, one solution may simply be have a pool of stock and shrink that as a percentage of the portfolio over time. Whereas other managers, and it's one of the things we do at American funds, but other managers will actually change that pool, so that we can get into this a little bit more, but we you know, so that what you own when you're 65 in the stock bowl is very different than what you owned when you were 35 or 40. And that's just another lever that you can pull to to mitigate risk within the portfolio while still managing it to a specific objective. And then and I'm happy to actually get into a little bit more of how we do that. 

But then finally and you pointed it out at the beginning the fees, and you know when you look at these high level, tangible difference Phase two or through glide path, and active or passive seem to be the ones that everybody looked at. And I and it's important fees are absolutely important. They're tangible you can you can measure them at any point. But value for the fee is also important and understanding what the long term outcomes will be for participants, and simply going with the least expensive doesn't necessarily bring you the best results. So it's a factor that needs to be looked at as part of the decision making process. In terms of what are we looking at? How are we making that decision? So if you look at these, you look at the type of glide path, you look at active or passive and ultimately, long term outcomes and the results for participants in the plan. Those are the things that we see as being real drivers at the decision making level when when trying to differentiate between different target date managers. 

Joe Gordon  10:55  
So john, this is Joe, what would you say to a retirement plan committee hypothetically, about how to best monitor the Qd a decision that they've made? What what types of factors should they look at? Should they even consider many RFP on the Qd a every three to five years, especially if the performance is competitive, but maybe not the best, or maybe the fees are a little higher than market because things are fairly fluid. And, you know, and obviously, for those that are listen to this podcast, they're just interested in how to keep out of harm's way with the regulator's on how to best discharge their responsibilities as fiduciaries. 

John Doyle  11:43  
So given that what we're, you know, I mentioned earlier, you know, more than 80% of plants are using target date as a default, what's what's also very important is the cash flow in these plans into the into the target date. And if, you know, looking at it, various researchers, and I think, including certainly his most recent one I looked at where, you know, 60 to 80% of new cash flow is going into the target date funds, depending on the plan, and depending on a number of other things, which really makes it the most important investment option in the plan. So, you know, you use three years, I think three years is a good timeframe, in terms of doing a deep dive, whether it's a mini RFP, or, or, you know, a fairly deep analysis of target dates and the markets, I think you need, you can't just set it and forget it, you really need to look and do your due diligence, and oversee how that how that option is doing how that fund is doing, relative to the reasons that you picked it in the first place. And that includes results, that includes fees, and includes something we haven't talked about yet, which is risk and volatility. Because if all you're doing is looking at investment performance, then you might be missing some other issues. If you're if all you're doing is looking at fees, you may be missing other issues. And I think one of the maybe one of the challenges that a plan sponsor has when they're making this decision is being able to kind of benchmark the tangibles and the intangibles. 

And one of the mistakes that I see being made is simply you know, going for the cheapest, the lowest fee, which isn't necessarily in the best interest of the participant, as a fiduciary that the goal is not to avoid litigation, the goal is to do what's best for the participant. That's that's your, that's your duty, as fiduciary. And one of those things is obviously cost. But that seems to be gaining traction in the press and other areas, because that's such a tangible and measurable issue that that people can latch on to. But what I think a plan sponsor, the decision maker needs to do is obviously take that into account, but also take the value that they're getting and the the risk measurements and volatility, that that actually impact how a participant views it on a day to day basis. Because the best results may come from extremely high volatility. And that may be okay. But be aware of that. And I you know, after what we saw in the first quarter, there were a number of investment managers and target dates, that that struggled a little bit during the first quarter. And my kind of response was, if if you expected that because of the level of rescue wanted to take on then you should be fine. And you should be okay. But if you didn't expect it, and if the if the volatility was greater than you would have thought, then then that's part of what you need to do is along with your due diligence, so whether it's every three years or it's after the type of year that we've had this year, I think there's real opportunity to do that deep dive into the QDIA. 

Look at 2020 is probably, you know, a real, an excellent period for stress test on your QDIA, because we really saw, you know, a, I don't want to call it a complete market cycle. But we saw a lot going on in 2020, which will give you an opportunity to look at how that how your QDIA held up during the volatility and downturn in the first quarter, how it came back, as the markets recovered, and the recoveries there were often led by growth. And, and, you know, a lot of the growth stocks that led that recovery. So you know, is that an aberration going forward? That's part of the process in terms of, of doing that due diligence and overseeing the QDIA. The challenge is, though, that, that there's really no benchmark I mean, you have the s&p benchmark for target date of the s&p two, benchmark, and you have the s&p three benchmark for target date. There are simply average Morningstar does want to they're simply averages of all the target date. asset allocations, as opposed to a true index. And so there's nothing to compare it to, on a on a one to one basis, you need to almost do it in a three dimensional capacity, where you would have an understanding of or an expectation of how your fund might do under certain circumstances, and did it did it do better or worse than the index, as expected, meaning if the if the fund is more conservative markets, it should lag the benchmark. And if it's more aggressive, in a market, that should lead the benchmark. So you should always have that multi dimensional view, when you're looking, we're using whatever benchmark you choose to use. 

Joe Gordon  16:47  
So john, what what what would you say in the last 18 to 24 months, from where you sit, have been the primary reasons that your firm has been successful in winning mandates and finals presentation. So what are the key differentiators that other than performance and sees that you feel like retirement planning committees put weight on to make a decision to hire your firm? 

John Doyle  17:15  
So I Well, one of the reasons is, fees are important. And we are the lowest cost active manager for target date funds in the mutual fund space. So I do think that, you know, I know you said other than fees, I do think that's one of the reasons we're at least at the table, and and folks are looking at us but and I always tell I tell our sales team, but I also when talking to a plan sponsor, investment results are important. But that's not where you should start. And I think what you really need to do is take a look at how the fund is managed and the philosophy behind the way the fund is managed. And I think an understanding of what we do at American funds with our target date has helped drive the selection of American funds in many plans, and cash flow into into those funds relative to the rest of the industry. So the way we look at it. And I mentioned earlier, we pension Protection Act was passed in 2006. And that's really when target date funds took off, we built our target date funds after the pension Protection Act. So we actually had the advantage of knowing that they could very well be a default in it for an individual in a retirement plan. And ultimately, they could end up being 100% of someone's investment or retirement savings. So with that in mind, rather than build target date as an Asset Allocation Fund, we built it as a portfolio. So we looked at it from a portfolio construction point of view, and not simply as an Asset Allocation Fund, that would be an option in a plan. And in doing that, we kind of looked at it with two primary objectives, build wealth, and also preserve wealth. And I think with a lot of asset allocation funds, it's almost an either or proposition where if you, if you lower the the the risk, you're lowering the equity exposure, you're lowering the long term opportunity for growth, but you're preserving wealth. And and the approach that we take is to try to do both at the same time. And and let me explain how we do that each building block within the within the portfolio has has a specific role. And that that role may change over time, but the building blocks change over time. So when you're in the 2055 or 2060 fund, you're generally younger, you can afford to take more risk. And that's, you know, that's the way we've always presented asset allocation and portfolios anyway. But you can take more risk because you have more time to make it up if the markets go down. And truthfully, the younger investors often have less money to lose.  

As you go move along the glide path so as you move along your time as an individual, you are, first of all, you're building wealth. So you have money, you have more money, as you approach retirement, you really have the largest pool of assets that you're going to have. And so it's important that you preserve what you've built. But I still think that a 60 year old or a 65 year old is a long term investor, you know, we we talked about managing glide past 30 years beyond retirement. I mean, a lot of those assets have a 30 year timeframe. So we want to maintain that equity exposure, but not the same type of equity exposure or stock exposure, that we gave the 30 year old or 35 year old. So rather than, for example, owning the Fang stocks, and you know, owning the more growth folk growth oriented, more volatile stocks, that a 30 or 35 year old, we start to, to move to more dividend paying dividend growing at what I call maybe even a more defensive stock position for those individuals as they approach retirement. So we're, we're using that lever to dampen volatility. So we're reducing the risk making it a little bit more palatable for participants who are in their 50s and 60s, through various stock market cycles. And, and yet, we're still maintaining that long term outlook, and the fact that we need to continue to help the balances grow, even after retirement, you know, it's, we don't want them going down immediately at age 65. We want to maintain that equity exposure as folks move through retirement. So that's one aspect of what we do differently. And actually, and, actually, I'll talk about the first quarter in a minute, because it was a good example of how that worked. 

But I don't want to skip over the role of fixed income and bonds, because when you think about it, when somebody is in their 60s, all of a sudden, we're talking about equity, and we're talking about, you know, the stocks within the portfolio, bonds actually make up more than 50% of the portfolio as you move into, or maybe the, you know, as you go into retirement. So one of the things that we do a little differently is, is we use fixed income for, for purposes, diversification from equity, as an income producer, inflation protection, and inflation shocks, because equity is still the best inflation protection, and then also capital preservation. And we've talked about bond funds that act like bond funds, we're not trying to stretch for return on the fixed income side, we're trying to use that as a risk mitigator, we obviously want good results. But we also want to protect the portfolio and protect the the equity side of the portfolio with with our fixed income. So when you take that defensive stance in the in equity side, and add to that the bond funds that act like bond funds, in a downturn, we see a lot less volatility than many of our competitors. 

So in the first quarter of 2020, relative to the largest providers of target dates, our funds really did much better. They were still they were still down, the markets were down at one point, equity markets are down over 30%. But we were probably four or 5% better than most target date fund providers during that period, because of the way we manage the underlying building blocks. And I think back to your original question, what sponsors are starting to understand is that the value of the active management underneath the hood in terms of the building blocks, but also that change in the characterization of the stocks and equity and fixed income, as you move along the glide path, which goes back to my original point of this as a portfolio, not an Asset Allocation Fund. And as a using portfolio construction, having a portfolio that fits the individual at their point along the glide path has really helped in our results, but it's also helped plan sponsors and decision makers understand where that value is coming from. And that is that has helped us win in a lot of these situations.

JOHN, those are some really great points. And I couldn't agree more, you know, the fixed income part of the equation, so what's under the actual hood truly makes a huge difference. In the portfolio construction. We see many target date fund providers sort of pat themselves on the back and say, oh, because we we hold more fixed income bonds, we're much more conservative than the other guys. And then when you actually look under the hood, some of the fixed income that they actually own could be, you know, high yield, wildly volatile type stuff. So you know on paper, in a very two dimensional view of the target date fund and glide path. Some folks think they are very conservatively positioned, but hey, when stuff happens, like like it did earlier this year, those more volatile type bonds can trade just as wildly as stocks. So that said, just Curiously, can you construct a situation in your mind where you think just a two glide path would be a better solution for anybody than a through type glide path?

So, so there, I think there's a little bit of a misperception around to versus through, and I think that I've heard many times is that the reason you would offer a to glide path is because participants leave the plan when they retire, and they don't, don't stay in the plan, they don't stay in the target date funds. So you don't need a through glide path. And I and I, I actually disagree on on two fronts. One is that even if they leave the plan, they may still choose to roll over with their target date fund or into the same target date fund. So you can't just assume that, that the money will not be put to work. And I and and you need to take that into account. But I will also offer that that's not how, or why a two glide path was constructed in the first place. I think that there is a a mindset or not a mindset, but but there's a there's a thought at the at the portfolio management level, that a retiree that is no longer receiving income, doesn't need a glide path, they simply need a portfolio for the next 30 years. And that's the that's the investment philosophy behind it to glide path. But I think that that's often lost. We don't agree, we think that that a participant at age 65, you know, should still have more exposure than than their lowest point. But the scenario you you ask for or describe would be for an investor or a plan sponsor that agreed that in retirement, a static portfolio with no glide path management made sense. And, you know, I think we look at what the way we do it, we think that makes sense for someone in retirement, it's modeled that way. It's modeled for withdrawals in a real world situation. But the scenario, for two would be more just believing that a static portfolio makes more sense, I don't think it's, I don't think the argument that people leave the plan, it really should be part of that discussion, because you don't want to the scenario that would would be dangerous in my mind is if you get too conservative at age 65, because you have a glide path, and that individual retires and goes to an advisor, and now has to kind of ramp up their portfolio at age 65, to take the appropriate amount of risk and get the appropriate amount of equity exposure. And they have created market timing risk, where if they do that at the wrong time, they move out of a to glide path and then into a portfolio with a greater allocation to equity. Just the timings wrong, they could they could be hurt by that. And they're better off simply on a glide path where they're at the right point, wherever they are a glide path when they choose to move to a similar portfolio outside the plan.

Todd Zempel  28:08  
So john, as we wrap up, and you look over the horizon, in the world of education and portfolio management, what are the things you're thinking about? And what are the interesting areas that you are exploring?

John Doyle  28:25  
So, you know, solutions will continue to evolve in retirement plans. And you know, I think, as I said, right at the beginning, I think we made some really Giant Steps with the Qd a definition and with target dates, because target dates, take a very complex decision making process from the participant and simplify it. For the participant, it's still a complex solution. I think that, as we see, especially as we see more assets go into target date, we'll continue to see the evolution of these types of solutions, and they will get better. The challenge, I think, is that a lot of the changes that we've seen are changes for the sake of change, and changes to differentiate as opposed to changes for the better. And and what we'll see in the future, I think, is ideally, changes for the better as well, that may mean more personalization, that may mean more choice for participants. But the challenge with choice is that once you put choice in the hands of the participants, you they freeze at times and and and don't make it. So what I'd like to see and what I see happening is this level and maybe a little bit more personalization for the engaged participant. And there may or may not be cost associated with that. But for the participants that that aren't sharing more information, the participants that aren't really that engaged this type of default solution still works well. And adding complexity really kind of defeats the purpose of what we've been able to achieve. So we'll continue to see evolution, and hopefully evolution for the better. I think we just need to be wary of change for the sake of differentiation and not for the sake of making it a better solution.

Todd Zempel  30:22  
Sounds great. Well, john, thank you so much for your time today. It was very insightful to hear your comments on the industry, and what you guys at Capital Group in American funds are doing. So, john, thanks for joining us. 

John Doyle  30:34  
Thank you. Appreciate the invitation.

Todd Zempel  30:37  
All right, folks, that'll wrap it up for today. Thanks a lot. And if you have any questions or would like to learn more about American funds or Capital Group, just google the name and you'll find the website no problem. Thanks a lot folks have a good one. 

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