When Selecting TDFs, Sponsors Overlook Allocation

Retirement plan sponsors and advisers are too focused on short-term performance when it comes to selecting target-date funds (TDFs). This is according to the MFS Defined Contribution Investment Trends Study, based on a survey of 606 plan sponsors and 313 advisers.

Nearly 60% of sponsors say they consider a track record of three years or less when selecting managers and will put a fund on watch if it begins to underperform even after one year.

“Many sponsors have succumbed to short-term pressures, and these are often misaligned with the long time horizons of plan participants,” says Ryan Mullen, senior managing director and head of MFS’ defined contribution investments practice. “The effectiveness and skill of an investment manager can only truly be judged over a full market cycle, which is longer than three years.”

When selecting a TDF, 66% of the sponsors and advisers surveyed said performance is the most important factor to consider, followed by fees (46%). On the other hand, only 40% of sponsors and 50% of advisers say that the allocation process is one of the most important factors to consider, followed by risk management, cited by 30% of sponsors and 35% of advisers.

MFS argues that rather than focusing on performance and fees, sponsors and advisers should be more attentive to portfolio construction and risk management. As Ravi Venkataraman, MFS global head of consultant relations and defined contribution, puts it: “The importance of asset allocation and risk management in driving performance is often overlooked. As we saw during the global financial crisis, these factors can have an out-sized impact on the performance of a target-date portfolio.”

In 2008, for example, 2010 TDFs from 20 of the largest providers that took investors “to” retirement suffered average losses of 19.76%, while those with a more aggressive “through” retirement glide path lost an average 27.16%.