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Introduction

Given the variety of target date options available in the marketplace today, how does a plan fiduciary determine which family is right for a specific plan? When evaluating target date options, it is important to keep in mind that quantitative factors play an important role. However, there is much more to target date options than a rating score or a performance track record over a single time period or environment.

The following is meant to address:

• what we believe should be considered when evaluating target date options and their objectives
• how to monitor target date options and perform ongoing due diligence
• the questions that should be asked of target date managers when deciding which target date family is right for a particular plan
• what to incorporate into an Investment Policy Statement (IPS)

Target Date Considerations

The first step in selecting and monitoring a target date family is to determine what the plan’s primary goals are and the objectives of the target date options. Examples of a plan’s goals could be to attract and retain top talent, control plan cost and complexity, and/or motivate employees through benefits to increase productivity. Examples of things plan fiduciaries need to consider in defining target date objectives are:

• participant demographics
• behaviors utilized by the majority of participants (e.g., retirement age, lump sum distributions vs. periodic payments, level of withdrawals)
• employee savings rates and employer match
• employee turnover
• degree of paternalism felt by plan fiduciaries
• what plan sponsors desire to happen and what are they willing to do to influence the outcomes
• goal of the target date options on the plan’s investment menu
• how aggressive or conservative the target date options’ glide path should be
• equity allocations at important points along the glide path (i.e., ten years prior to the target date, at the target date, and the landing point)

After determining and documenting the plan’s goals and the target date option’s objectives, plan fiduciaries can evaluate target date options in light of the plan’s specific needs. Given the various moving parts that comprise target date options, evaluation methodology may not be as simple as what has historically been used to evaluate single asset class options. When evaluating, selecting, and monitoring target date options, we believe plan fiduciaries should expect effective target date families to:

• incorporate a glide path that fully addresses a participant’s changing investment objective over time, with consideration given to the prevailing market environment
• utilize an active approach to asset allocation and risk management
• be managed by a team that has a long-term track record of proven performance results over a variety of market environments
• have a mechanism in place to facilitate coordination among all professionals involved in the investment decision making process
• be effectively, but not overly, diversified among underlying portfolios/securities
• have reasonable expenses relative to the value provided by the investment strategy

Target Date Objectives

The target date options should be comprised of a coordinated family that includes, but is not limited to, one “Income” option positioned in a conservative, income-oriented manner, and additional options with target dates set in five-year or ten-year increments [e.g., Retirement Target (RT) Income, RT 2010, RT 2015, RT 2020, RT 2025, RT 2030, RT 2035, RT 2040, RT 2045, RT 2050, and RT 2055]. In general, each option should start with a higher equity allocation and become progressively more conservative as the target date approaches. In addition, each option’s current asset allocation should be actively adjusted based on prevailing market conditions.

Specific objectives of the target date options should be to:

• meet a set of investment objectives related to the participants’ particular target dates
• adjust the investment objectives as the time horizon shortens taking into consideration how objectives will change over time
• incorporate a glide path that will gradually adjust each option’s equity exposure to become more conservative as the target date approaches
• define an approximate date of retirement or date when assets are needed to meet ongoing living expenses

Questions to ask your Target Date Manager

After the basic questions, such as how many options are offered and at what intervals, who makes up the management team, and what vehicles are available, a more in-depth analysis should be conducted to fully evaluate a target date family in light of the plan’s specific needs and objectives. Therefore, target date managers should be able and willing to provide the answers to the following questions.

• Explain (in detail) the glide path of the target date options. When do roll downs occur? Is it consistent every year?
• Is the glide path actively managed or is there a rebalancing program in place?
• What are the equity allocations at various stages of the glide path (i.e., early career, mid career, near/in retirement)?
• What is the slope of the roll down prior to the target date?
• When does the glide path reach its landing point?
• Have there been any changes to the glide path or investment processes since inception?
• How long has the current management team been in place, and how do they work together (i.e., how are investment decisions made)?
• How many underlying management teams play a role in the security selection for the target date portfolios and what is their respective tenure?
• What are the underlying holdings and what criteria are used to add or remove them?
• What level of diversification is provided on an underlying security level?

The answers provided by the target date manager can help plan sponsors select the optimal structure for their target date options. Target date options should be structured in a way to help participants meet desired retirement savings goals and achieve the needed level of retirement income. For plan sponsors whose primary concern is longevity risk, capital growth, and ensuring participants accumulate enough retirement savings to generate long-term retirement income, target date options with higher allocations to equities (a more aggressive glide path) may represent a more appropriate choice. In contrast, a more conservative glide path (lower allocation to equities) might be more important to plan sponsors who wish to focus on the potential for less volatility at the target date and the risk of losing capital. Similarly, when looking at target date track records, a major change to a target date option’s glide path methodology or management team is a good indication that past results may not be an indicator of what to expect going forward. In order to understand how a target date family may behave in varying environments, a target date manager should be able to clearly articulate their investment process and the methodology used in creating the glide path. In addition, understanding the specific reasons for the selection of the target date options’ underlying holdings will help shed light on whether or not they were selected based on investment opportunities or to fill pre-determined diversification buckets.

Target Date Monitoring and Ongoing Due Diligence

Once target date options have been selected, they should be monitored on an ongoing basis to confirm that they continue to meet the objectives and criteria under which they were selected. We believe the following should be monitored on a quarterly basis:

• changes in participant behavior, plan demographics, or plan design
• any changes to management, the glide path, asset allocation strategy, or the investment process
• performance versus an industry standard benchmark and peer group medians over trailing time periods and a variety of market environments
• the market environment and the portfolio’s positioning and allocation by asset class, sector, and underlying holdings, both currently and going forward
• performance attribution on an allocation, sector, and security selection level

The following describes a sampling of “trigger alerts” that may occur, which can begin the process for the plan fiduciaries to evaluate the target date options and consider any appropriate action. It should be noted that the triggers should work as guidelines and should not be considered as an argument for or against removal or replacement. No option will outperform over all time periods. When evaluating a target date family, it is important to fully understand the investment process so it can be determined whether the options are behaving as expected within the scope of that investment process. These triggers should encourage a dialogue with management to garner an understanding of the current situation. In addition, the plan fiduciaries should reserve the right to take action on the target date options (continued commitment or removal) for these or any other reasons not outlined below. After a full evaluation, plan fiduciaries may want to take one of the following courses of action: do nothing, place the target date family on a “watch list,” or consider removing and replacing the target date family.

Trigger Alerts

Additional in-depth analysis, including discussions with management, should be conducted on a regular basis. No manager will outperform in every environment, so it should be expected that there will be time periods when a target date family’s investment approach is out of favor. However, plan fiduciaries may want to immediately investigate when the target date portfolio has:

• performance that is unexpected based on the investment approach
• undergone a change in management
• had excessive changes in management of the underlying portfolios
• made substantial changes to the glide path
• gone through a significant change in investment process or in asset allocation methodology
• underperformed versus peer group medians and/or a representative index over a period that encompasses a variety of market environments
• experienced a continuous period of underperformance that has resulted in sustained loss of capital versus peers in the near dated or Income option
• experienced unfavorable market capture ratios when compared to a representative index, in the longer-dated or more equity oriented options
• become too concentrated or has added additional holdings and is now over-diversified
• above average expense ratios relative to peers with similar fee structures
• is no longer appropriate for an ERISA retirement plan based on an ethical breach in conduct by the firm or management

We also highly recommend documenting the analysis, findings and the resulting course of action. In addition, while any of these occurrences may be cause for additional analysis, plan fiduciaries have ultimate responsibility for how these “triggers” shall be interpreted and how to apply them for the exclusive benefit of the plan and its participants.

Incorporating the IPS

In general, we believe that the following elements are indicative of an effective IPS for a 401k Plan:

• establishes the plan’s overall goals and objectives
• defines roles and responsibilities for various parties (e.g., fiduciaries, service providers, etc.)
• outlines the plan’s general menu design philosophy
• provides details on the plan’s qualified default investment alternative (QDIA) and methodology used to default participants
• details investment option selection and monitoring philosophy and criteria
• provides details on the various investment roles including objectives and risk management priorities
• outlines process for ongoing review of the plan’s fees, performance, service levels, and capabilities

Historically, an IPS addressed selection and monitoring criteria for single asset class options. However, target date options have unique nuances and are much more difficult to evaluate and monitor. Given the level of detailed analysis involved with selecting a target date family, it is important to incorporate the specific target date objectives and selection criteria as defined above into the plan’s IPS.

While it is important to document what has and will be done in all aspects of fiduciary monitoring for a 401(k) plan, we recommend making objectives and criteria as general as possible to avoid having to make decisions based on a short-term trend or due to the prevailing macroeconomic environment. In addition, the IPS should be reviewed, updated, and modified as appropriate on a periodic basis to reflect changes in the investment environment, option performance, and plan needs.

Conclusion

Target date options are proving to be a useful tool for plan fiduciaries when helping participants prepare for retirement. As the universe of target date options has evolved, it has become clear that there are as many different ways to manage a target date glide path as there are target date families. How the target date options are selected and monitored, what specific factors should be considered by plan fiduciaries, what questions need to be asked of target date managers, how the target date family should be monitored going forward, and what should be included in the IPS all need to be carefully vetted and considered.

The selection and ongoing monitoring of target date options should include many variables, and we believe that the most important variable of all is transparency, or the ability of the target date manager to illustrate how they manage the glide path and investment process for target date options. Only after a full in-depth analysis is complete will plan fiduciaries be in a position to select target date options that are appropriate for a specific plan. Keep in mind that the work does not stop there, as plan fiduciaries should include the criteria and objectives stated in the plan’s IPS as the guidelines for evaluation and monitoring going forward.

Manning & Napier’s life cycle offerings include target date (age-based) and lifestyle (risk-based) mutual funds (Manning & Napier Fund, Inc. Target Series and Pro-Blend^® Series) and affiliate collective investment trust (CIT) funds (Manning & Napier Pro-Mix^® CIT Funds, Retirement Target CIT Funds, and GOAL^SM CIT Funds).

Because life cycle funds invest in both stocks and bonds, the value of your investment will fluctuate in response to stock market movements and changes in interest rates. Investing in life cycle funds also involves a number of other risks, including issuer-specific risk, foreign investment risk, and small-cap/mid-cap risk as the underlying investments change over time. Additionally, some target date funds invest in other funds and therefore, may have additional risks associated with the underlying funds. Principal value is not guaranteed at any time, including at the target date (the approximate year when an investor plans to stop contributions and start periodic withdrawals).

For more information about any of the Manning & Napier Fund, Inc. Series, you may obtain a prospectus at www.manningnapier.com or by calling (800) 466-3863. Before investing, carefully consider the objectives, risks, charges and expenses of the investment and read the prospectus carefully as it contains this and other information about the investment company.

Manning & Napier Advisors, LLC (Manning & Napier) provides investment advisory services to Exeter Trust Company (ETC), Trustee of the Manning & Napier Collective Investment Trust funds. The Collectives are available only for use within certain qualified employee benefit plans. The Manning & Napier Fund, Inc. is managed by Manning & Napier. Manning & Napier Investor Services, Inc., an affiliate of Manning & Napier and ETC, is the distributor of the Fund shares.