Challenging conventional wisdom on target date fund design
Ron Surz, president of Target Date Solutions, details the TDF index he created.
RON SURZ, A STRONG ADVOCATE OF the “to retirement” target-date fund glide path model, is president of advisory firm Target Date Solutions. He earned an MBA in finance from the University of Chicago and an MS in applied mathematics from the University of Illinois. Employee Benefit News recently spoke with Surz about TDF design and the fiduciary obligations plan sponsors face in retirement plan fund selection. Highlights of that conversation follow.
Employee Benefit News: What distinguishes your index from others?
Ron Surz: The other indexes are what I call consensus indexes. And so Morningstar has them, S&P, Dow Jones, but they’re primarily an assembly of what the target-date fund industry is doing. Fiduciaries who use those are exercising “procedural prudence,” by measuring themselves against what the industry is doing. But that’s not what I do. By using what I think is the best glide path, I’m offering something to fiduciaries who are trying to exercise “substantive prudence”— doing the best you can, not just following the crowd.
EBN: Are you aware of any litigation initiated on behalf of plan participants claiming that their TDF glide path was inappropriately designed to meet their needs, such as being too heavily allocated to equities when participants are close to or at retirement?
Surz: I think the answer is “almost yes,” but I’m not aware of anybody specifically challenging the glide path.
I do think there are lawsuits out there right now that, among other things, argue that the plan sponsor did not vet their target-date solution.
So they didn’t shop at all, they didn’t look at many or any of the alter-
natives. Ostensibly the issue is about fees, but there’s a case involving Vanguard, which has the lowest fees in the industry. They’re being sued by their own employees, so it can’t be just about fees, it’s about the vetting process.
In general, it’s all about thinking about what participants really need, which target-date fund comes closest to doing the best for participants, and not just going with one of the biggest bundled fund providers.
EBN: Why do you think there hasn’t been any litigation specifically tied to a TDF’s glide path?
Surz: It has to do with harm. If a participant has assumed a lot of risk with a high equity allocation, but due to good equity market performance, hasn’t been harmed by the glide path, he won’t sue. I think it came close after the crash in 2008. I spoke to several attorneys in 2009 and 2010 who said there was harm, but people were focused on other issues like fees. The next time there’s a big drop, I think it will be different.
EBN: What is your guiding principle in designing your TDF model?
Surz: As I have stated in the Fiduciary Handbook for Understanding and Selecting Target Date Funds, an e-book that I co-wrote with an ethicist and an ERISA attorney, cap- ital preservation should be the universal objective of TDFs. The Hippocratic Oath of TDFs should be, “lose no money.”
EBN: That’s quite evident in your own TDF model’s glide path, in which you take investors to about a 90% cash allocation when they hit the target year, and put the onus on them to reset their allocation to whatever they consider appropriate at that time. But is there a significant risk that inertia will set in and they won’t reset their allocation to whatever’s most appropriate?
Surz: One of the threats to retirees’ capital preservation that seems to be under-appreciated in the glide paths of most TDFs is something called the “sequence of return” risk. The bottom line notion is if you’re about to start spending, drawing down on that money, you care a real lot the sequence that returns are earned.
If the loss is incurred when retirement is 20 years down the road, that’s much less painful than having it happen the very first year that you need to start drawing on that portfolio.
EBN: Your philosophy about risk and equity exposure in TDFs certainly sets you apart from your peers. Do you feel like a voice crying out in the wilderness?
Surz: Yes, I do.