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Growing Interest in Volatility Smoothing Solutions for TDFs

Target Date Funds

While few target date funds currently include strategies to reduce volatility with the ability to enhance returns, which are principles of stable value, there appears to be significant interest in features that can do both, according to MetLife’s 2022 Stable Value Study. 

If a TDF provider could utilize a solution, such as stable value, that could generate net returns four times more than the cost associated with delivering those incremental returns (e.g., 60 basis points enhanced net returns for a cost of 15 basis points) while keeping volatility constant, 89% of plan sponsors and 97% of advisors would be interested in this feature, the study notes.  

There also is significant interest—86% of plan sponsors and 94% of plan advisors—in a feature that could maintain comparable returns, net of fees, while reducing volatility by approximately 40%.

MetLife notes that more than $2 trillion dollars of retirement savings are invested in TDFs, and as they increasingly dominate DC plan investments, stable value—with its ability to smooth out volatility—enables TDF providers to optimize the risk/return profile of their funds to fit the profile of the plan participants invested in TDFs.

“While TDFs may provide a simplified experience for plan participants, plan sponsors need to take a closer look at how these funds address the potential impact of market volatility,” says Warren Howe, MetLife’s national director of Stable Value Markets. In fact, the study found that nearly one in five plan sponsors (18%) are likely to say that it is “very or somewhat common” for plan participants to delay retirement due to experiencing market losses in their TDFs.

The volatility smoothing principles of stable value can also be applied in TDFs, notes Howe. “This includes both off-the-shelf TDFs and custom TDFs, which may offer a better opportunity to implement these strategies. These solutions can significantly lower volatility while maintaining returns or, conversely, enhance returns while keeping volatility constant,” he suggests.  

Although off-the-shelf TDFs are the most popular, interest in custom TDFs may be growing. According to the findings, 27% of advisors are considering recommending or constructing custom TDFs for their plan sponsor clients, and more than half of plan sponsors without a custom TDF say they would consider a custom TDF based on their advisor’s recommendation.

Volatility and Preservation

When plan sponsors were asked about their level of concern regarding the ability of DC plan participants to mitigate the impact of market volatility, many expressed concern—particularly among those already retired or approaching retirement.

In fact, more than two-thirds of DC plan sponsors are concerned about the impact of market volatility on retirees (70%) and plan participants within 10 years of retirement (67%), according to the study. More than half (52%) are concerned about those more than 10 years away from retirement. 

Stable value remains the most popular capital preservation option for plan sponsors, MetLife notes. Most DC plan sponsors (82%) offer stable value and nearly all DC plan sponsors (98%) say they are not planning to make any changes to their stable value offering. 

Additionally, more than 9 in 10 stable value fund providers (91%) say plan sponsors chose stable value because its returns are better than those of money market funds and other capital preservation options, and nearly half say that advisor recommendations (45%) are the primary reasons. At the same time, the use of money market funds has declined significantly since 2015, with fewer than half of sponsors (48%) offering money market as a capital preservation option today—down from 62% in 2015, MetLife notes. 

“By embracing solutions such as stable value in TDFs, plan sponsors can take steps to address their concerns about the impact of market volatility for retirees and near-retirees,” says Tom Schuster, senior vice president and head of Stable Value and Investment Products with MetLife. “With access to these solutions in TDFs, participants can take a ‘set-it-and-forget-it’ approach to their retirement with the security that their savings are protected against volatility.”

MetLife commissioned Greenwald Research to conduct surveys of plan sponsors, advisors and stable value fund providers, between June and October 2021. A total of 222 interviews were completed among plan sponsors who offer a 401(k), 457 or 403(b) plan. Assets under management for plans included in the study ranged from under $10 million to over $1 billion. Each respondent had to work for a company that offers a DC plan with TDFs or target risk options, offer a capital preservation option, and has at least a moderate amount of influence over decisions regarding stable value or related funds. Online surveys were also completed by 49 DC plan advisors and 11 stable value fund providers.