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: How did you get involved in the whole target date funds arena?

Surz: I started with a couple of partners back in 2006 to develop some target date funds when the Pension Protection Act addressed TDFs as a qualified default investment alternative. I left that partnership in 2009. But one of my partners, Craig Israelson, as I was designing this, was modeling and testing it out, and in the end we came up with a really solid design. And I started showing it to people, including David Hand who is the owner of Hand Benefit Trust in Houston. They had their own target date funds, but when he saw my design, he said, “That’s what I want to use for my people.”

EBN: And then?

Surz: In 2008, [Hand] hired me to be the sub-adviser for the “Smart Funds” target index series. But Hand Benefit Trust is not marketing this target date fund. It was originally there for its own employees, and it almost remained a secret, although couple of their clients did decide to subscribe to it. It has about $25 million in it now, because Hand watched as other fund companies that used their own funds for their employees got sued by their employees, and decided it was better to use other asset managers for his employees.

EBN: But you also use your fund models to create an index for benchmarking purposes, correct?

Surz: Yes, I have been doing that since July of 2014, with underlying passive funds. We started publishing that and it’s available on Morningstar now. So if you go to the Morningstar index section you’ll find the Smart Target Dates Fund Indexes. And I also have it on my website. I’m not sure who all is using it, so I really can’t say how much money is invested based on my models.

EBN: What distinguishes your index from others?

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.

EBN: And what is that?

Surz: 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 alternatives. 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 his 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: Do you expect that the Department of Labor’s pending fiduciary regulations, that were postponed by the Trump administration, will be finalized, and if so, what impact will they have on plan sponsors?

Surz: I think they will survive. Most of the attention has been focused on their impact on advisers, but they impact plan sponsors, too. Sponsors can delegate some responsibility, but they still own it all. Their responsibility doesn’t end when they hire an adviser who is a fiduciary.

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, capital preservation should be the universal objective of TDFs. The Hippocratic Oath of TFDs 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 isn’t there a significant risk that inertia will set in and they won’t reset their allocation to whatever’s most appropriate, to their detriment?

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, like the 2008 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. There’s a risk zone and it spans about the first five to 10 years of retirement. If during that time period there’s a big loss, it’s going to change your standard of living.

EBN: But if a retiree has a relatively meager portfolio at retirement, isn’t there an equally or greater risk associated with essentially giving up the opportunity for capital appreciation with a 90% cash allocation?

Surz: Target date funds are sold with two objectives: replacing pay and managing longevity risk. Neither one of those can be achieved without one key ingredient: that the investor saves enough. If the investor has not saved enough, there is not a thing you can do for him, and that’s just the unfortunate reality. That said, as the participant nears the date he is going to retire, he starts to make plans. And the rich people plan to buy yachts, and the poor people plan to try to put together a shack somewhere in the desert. But in both cases, if you cut off their legs with a loss early in their retirement, that all changes. You get a smaller shack or you’re buying cat food and living underneath a bridge.

EBN: But your glide path doesn’t stop adjusting at retirement…

Surz: Yes, I have a U-shaped glide path, and during the risk zone, 5 to 10 years before and after retirement, it’s very, very safe. But then when the retiree gets to be 75, 85, 90 years old, I’ve got to ratchet up the equity exposure.

EBN: What is your opinion of customized TDFs that are supposed to take into consideration the unique demographics of different organizations?

Surz: My most cynical explanation of why they have become popular is because the advisers want to get paid, and I think most customers of target date funds now are being sold by the plan’s consultant. So the consultant sits there and thinks, “We’re going to send a ton of dough over to T. Rowe or Fidelity or Vanguard, I can get some of that. So let me design a custom TDF.” And by the way, I really think that the adviser’s “custom” TDF is probably really a cookie cutter.

EBN: But isn’t there some merit to the underlying argument that allocations and glide paths might be different for a company with, for example, highly paid employees, than one with lower average pay?

Surz: I don’t really think you can say, “I’m going to match the plan demographics.” The best you can do to match demographics would be to match some sort of averages. The average account balances, average this, average that, but that’s not custom; it’s average. The bigger issue is participants don’t understand the risk they are exposed to. What we learned in 2008, among other things, is that participants had no idea that they were exposed to that kind of loss. And participants today have no idea they are exposed to that kind of loss. They believe that because they were defaulted into the fund, that their employers are keeping them safe. Fifty-five percent in equities at the target date is not safe.

EBN: Still, there’s a trade-off, right? The funds you advise may be safer, but that has certainly impacted their relative performance, hasn’t it?

Surz: So at the short dates, I have essentially no equities. And no equities at the short dates has not been the place to be in terms of performance. At the long dates I’m very well diversified, translated not nearly as much in U.S. stocks as my competition. And U.S. stocks have been the place to be, but our equity allocation isn’t limited to U.S. stocks. So because of that, over the last five, six years anyway, you could say we’ve been penalized.

EBN: Do you believe that, with more time, things will level out and you’ll catch up?

Surz: That’s my expectation. Also, if we had been having this conversation three years ago and 2008 numbers were included in the performance measurement, we’d look much better, because we were only down 10% that year.

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.

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