Skip to Content
Investing Specialists

Jerome Clark: 'We Tend to Become Myopic in a Bear Market'

The manager of T. Rowe Price's target-date series discusses the firm's more stock-heavy allocations, how target-date funds keep investors in their seats, and the puzzle of retirement decumulation.

Listen Now: Listen and subscribe to Morningstar's The Long View from your mobile device: Apple Podcasts | Spotify | Google Play | Stitcher

Our guest on the podcast is Jerome Clark. He is the portfolio manager of the asset-allocation target-date strategies and oversees the college savings plan portfolios in T. Rowe Price's multi-asset division. He's also a member of the firm's asset-allocation committee and serves on the multi-asset steering committee. Clark joined T. Rowe's fixed-income division in 1992 as a portfolio manager of the firm's U.S. Treasury Long Term Bond strategy. He began managing multi-asset portfolios in 2001. Before joining T. Rowe Price, Clark was a captain in the United States Marine Corps and a mathematics instructor at the U.S. Naval Academy. He earned his bachelor's degree in mathematics from the U.S. Naval Academy, his master's in operations research from the Naval Postgraduate School, and his Master of Business Administration from Johns Hopkins University. Clark is also a CFA charterholder. 

For his accomplishments during his tenure, Morningstar analysts recently named Clark the winner of the Outstanding Manager Award at the 2020 Morningstar Awards for Investing Excellence. He's slated to step down from his current role in early 2021.

Background
Jerome Clark bio 

"Winners of the 2020 Morningstar Awards for Investing Excellence," by Sarah Bush, June 22, 2020. 

"Meet the U.S. Winners of Our Awards for Investing Excellence," by Christine Benz and Sarah Bush, Morningstar.com, June 22, 2020. 

"Pioneer of Target-Date Funds Looks to the Future: Hedging and 'Tail-Risk' Strategies," by Howard Gold, MarketWatch, July 16, 2020.

Target-Date Funds
Target-date fund

Liability matching 

Pension Protection Act of 2006

"The Pension Protection Act's Impact on Defined-Contribution Plans," T. Rowe Price, May 2016. 

"Success Story: Target-Date Fund Investors," by Jeffrey Ptak, Morningstar.com, Feb. 19, 2018. 

"Mind the Gap 2019," by Russel Kinnel, Morningstar.com, Aug. 15, 2019. 

"Brigitte Madrian: 'Inertia Can Actually Be a Helpful Thing'," Morningstar.com, April 22, 2020. 

Glide Paths/Asset Allocation
T. Rowe Price Target-Date Glide-Path Design 

"Beyond Averages: A More Robust Approach to Glide-Path Design," by Lorie Latham, Zachary Rayfield, and Kathryn Farrell, T. Rowe Price, Jan. 16, 2020. 

"Enhancing the T. Rowe Price Glide Paths," by Jerome Clark, Kim DeDominicis, and Wyatt Lee, T. Rowe Price, February 2020. 

Retirement Decumulation
Sequence risk 

"The Art and Science of Developing Retirement Income Strategies," by Jerome Clark, Kim DeDominicis, and Wyatt Lee, T. Rowe Price, 2019. 

Qualified default investment alternative (QDIA)

Monte Carlo simulation

Transcript

Jeff Ptak: Hi, and welcome to The Long View. I'm Jeff Ptak, global director of manager research for Morningstar Research Services.

Christine Benz: And I'm Christine Benz, director of personal finance for Morningstar, Inc.

Ptak: Our guest today is Jerome Clark. Jerome is the portfolio manager of the asset-allocation target-date strategies and oversees the college savings plan portfolios in the multi-asset division of T. Rowe Price. He's also a member of the firm's asset-allocation committee and serves on the multi-asset steering committee. Jerome joined T. Rowe's fixed-income division in 1992 as a portfolio manager of the firm's U.S. Treasury Long Term Bond strategy. He began managing multi-asset portfolios in 2001. Before joining T. Rowe, Jerome was a captain in the United States Marine Corps and a mathematics instructor at the U.S. Naval Academy. Jerome earned his bachelor's in mathematics from the U.S. Naval Academy, his master's in operations research from the Naval Graduate School, and his MBA from Johns Hopkins University. Jerome is also a CFA charterholder. For his accomplishments during his tenure, Morningstar's analysts recently named Jerome the winner of the Outstanding Manager Award at the 2020 Morningstar Awards for Investing Excellence. He's slated to step down from his current role early in 2021.

Jerome, welcome to The Long View.

Jerome Clark: Thank you. Thank you for having me.

Ptak: To start off, you have a background in fixed-income management and mathematics. Talk about how that lent itself to managing retirement-oriented multi-asset portfolios. For instance, did you find your grounding in things like liability matching, clarifying as you came to think about how to apply those concepts in a retirement savings context?

Clark: Well, I'd say based upon my background--two things in my background, not just only my fixed-income experience, but leading up to that, I was a math instructor at the Naval Academy, and so a lot of analysis goes into the design of the product areas that I work on in the target-date space. And so, that type of evaluation where I'm using quantitative methods, working with other Ph.D.s and mathematicians who are building models, those things really help contribute that type of approach that you use in fixed income. Some of those aspects were absolutely applicable to designing and modeling and developing an approach for a target-date product.

Ptak: How so? Can you expand on that maybe with an example?

Clark: One of the things that we're known for in the target-date space is that we came up with a different design than everyone. It's not as different today, but pretty dramatically different back then. Back in the early 2000s a typical target date had 30%-35% equity, for example, at retirement. We actually launched at a 55% equity allocation. And back in that time, that was a pretty dramatic step in a different direction than other providers out there.

That was the result of me working with an individual--his name is Jim (Tessoro), and he was an instructor at Johns Hopkins. He's Ph.D. in mathematics. My background is in operations research, Jim focused in on the forward-looking, really sophisticated Monte Carlo analysis. And I focused in doing my own separate independent analysis, focusing historically, focusing on the mathematics, the statistics that we're finding. Independently, the two of us came to the same conclusion when it came to investors within 401(k) plans or savings for retirement is that we not only had to get them out of these, which at the time were really common money markets, stable value--we had to move them out on the risk/return spectrum. But our conclusions, independent conclusions, told us we had to move these investors, these participants, these employees in the 401(k) plans even farther out, much farther out, along the spectrum than other investment managers. I think it's because of that math background that Jim and I had that got us to taking such a different position than the rest of the marketplace.

Benz: We want to spend time drilling into the specific glide path that you use. But let's talk about getting the concept of target-date funds off the ground. Now, it's a huge trillion-dollar-plus market. But take us back to the beginning and talk about what were some of the biggest barriers that you confronted internally at T. Rowe and in the marketplace when you first introduced the concept.

Clark: Well, you know, it even goes farther back than when we started. When I think about what got us there is when you look at the background in the 401(k) industry, starting off in the 1970s, a lot of employees – I would say the industry basically did a hands-off approach for their employees. It's really given them choice and let them choose how they want to move forward. And you fast forward a couple of decades and what we're finding is--getting into this market and really learning 401(k) market, I just have a different appreciation for the word inertia. It's this overwhelming challenge that can work to the detriment or to the benefit of employees, but it's just huge in that they just tend to be hands-off investors. What we find is about 80% of typical employees out there in the marketplace are hands-off. They either don't have the interest or they don't have the time to go and handle and make the right decisions when it comes to investing.

So, because of that, what we saw was plan sponsors trying to overcome this challenge with inertia started moving away from defaults that were single options, offerings--focusing on options that gave them a wide range of choices. They started cutting down the number of choices. And then they started doing what we call auto investments. They started offering these asset-allocation products, a high focus on balanced funds that provided diversification. Then came target-risk products. And then following behind that were managed accounts and target dates. Target dates really took off because they really resonated for individuals, because they take so many things out of their hands. They don't have to worry about being asset-allocation experts; they don't have to worry about being economists and following the markets and figuring out what sectors to be invested in. That puts all of that in the hands of the investor. And additionally, as their circumstances change, primarily time, it automatically took that into account and adjusted their asset allocation based upon the change in their age.

So, fast forward when we launched ours, as I mentioned before, it was surprising to me going out in the marketplace, talking to plan sponsors, employers, talking to advisor consultants and finding out there was really this major hurdle to overcome because moving out on the risk/return spectrum--from not even the participant level but from the plan sponsors perspective--it just made more sense to do a more conservative, less volatile money market or stable value offering. Keep in mind, when PPA [Pension Protection Act] and what made target dates and other asset-allocation products a safe harbor, that moved the industry, but we were well ahead of that. And it was quite challenging to get employees to get comfortable with moving out on the risk/return spectrum for their default options.

Ptak: We want to get into some of the specifics of constructing target-date funds and in particular glide paths, which is something that you've referenced a couple times. But before we do that, since you alluded to it, it seems like part of the beauty of target-date funds is, as you mentioned, it removes the need to make decisions on a lot of things that are quite elemental to investing--the asset allocation, the investments that make up the asset allocation, the rebalancing, the shifting of the mix as time goes on. Those are all mechanized by the target-date fund. And so, my question for you is, in general, do you think investors ought to focus on making the fewest decisions possible?

Clark: I really do. I think that's a great question. All of our analysis, it doesn't matter if we're doing the more sophisticated Monte Carlo analysis or historical analysis, it really points to the biggest way that individuals can influence positively or negatively their retirement outcomes is through how much they save. And that's what I really love about asset-allocation products. Because it takes all those things out of their hands, it really allows, one, the plan sponsor to focus in on messaging the really important thing for their participants, that is how much they save, they can really focus that message. And for the employee, because they have all those other things on their hands, they actually have more time in ability to focus on that. I joke, sadly joke, but there's a lot of truth to it about the fact that many individuals, many employees will spend more time planning a summer vacation each and every year than they will monitoring and managing their retirement assets. It's scary to think that but it's actually the reality of them being hands-off investors. Just as we wouldn't look for the typical investor or individual to be able to conduct surgery, it's kind of unrealistic to think that most individuals are really well prepared to make the variety of investment decisions they need to make to do a good job investing in their 401(k) plan. So, it's one of the things that's wonderful about asset-allocation products and why target dates have resonated so much with plan sponsors and with their participants in taking those decisions out of their hands and putting it into the hands of a professional investor.

Benz: What have you and T. Rowe learned about retirement plan participants in terms of which of them are well suited to doing it for themselves and making their own choices and which are better off in a do-it-for-me product like a target-date fund?

Clark: Here's a really interesting thing. I've mentioned that 80% of investors are hands-off. But what we find is that it's hard to find an individual that an asset-allocation product is not appropriate for. We find even with those hands-on investors, a lot of times they tend to be too busy to be able to really maintain the vigilance of monitoring and doing the decisions on an ongoing basis. The other interesting thing we found is that some believe, like, "Oh, if you look at a certain industry, you would expect them to be more hands-on"--such as doctors and lawyers, relative to maybe someone in the hotel industry, maybe somebody in the food industry. But what we find is that no matter what type of industry you're looking at, no matter what type of company, it generally still falls out 80%. Now, the reason why it may be 80%, may be different, for some, it's about interest and ability to do all those things. In other industries, it may be more about time. But generally, across the board, no matter what sector you're looking into, what type of employee you're looking at, they tend to be hands-off investors.

So, we would say, it's very few that would not benefit from an asset-allocation product. And even for those hands-off [investors], they might be better off investing the core component of their investments, than the majority maybe, into an asset-allocation product such as a target date, and then doing that hands-off around the edges, you know, 10%, 15%, 20%, and utilizing that percentage as their hands-on.

Benz: So, have you had the opportunity to compare side by side the performance of hands-on investors who are selecting their own funds relative to investors in the target-date funds? And what kinds of conclusions did you come away with from that?

Clark: We have. And T. Rowe Price is not the only one that has done this evaluation. So, it's pretty consistent across the board that what you find is, in general, those investors that are invested in a target-date product, they tend to over their intermediate and long term do better than those that are outside of a target-date product. Some of the wonderful things that I love about target dates is they address some suboptimal behaviors. We had talked about the fact that many don't have the time, the inclination to come up to speed and become experts and really knowledgeable in a lot of these different investment arenas that are required to do well in saving for retirement. And so, for example, some of the behaviors that we see, they're pretty extreme sometimes.

For example, when we look at 20-year-olds to 35-year-olds, what we find is about one in five of them put about 80% of their allocation into cash. At that age, that is a really extreme, really scary allocation. It gives me the heebie-jeebies to actually think about because all our analysis shows that things such as being really conservative, such as in a money market or any similar type of instrument, really bodes for an unsuccessful retirement. If you shift to the other end of the spectrum, and you look at, for example, 50- to 65-year-olds, we find about 40% of them have an allocation of 20% or less in equities, which we would say is pretty extreme to the low end--that's too small. But then we see another--I think 33%--that are allocated in 80% or more in equities. That, we would say, at that age is also extreme, but at the other end.

So, what we find is that the typical asset-allocation product, a typical target date, takes these extreme behaviors, takes these investors who would tend to be extreme and puts them into a more appropriate, more moderate allocation at those different ages. Another thing that we see is investors tend to chase returns, that whole buy high/sell low syndrome. And I think 2008 is a great example when you look at those that did tend to make changes in that environment, that dramatic once-in-a-lifetime environment, many of them were actually acting in the opposite direction, such as we were, the investment professionals, in that extreme down equity market, we were moving billions of dollars out of fixed-income markets and within our products into the equity market, whereas most of those investors were actually doing the opposite and to their detriment.

Ptak: I wanted to build on that. Our research has found that there are smaller timing gaps, that is, differences between funds' dollar-weighted and time-weighted returns in target-date funds than in other types of funds. Based on the research you've conducted into participant behavior, do you think this is more a function of regular contributions to plans that participants are making? Or is it intrinsic to target-date funds themselves? Or a little bit of both? You mentioned the side-by-side study that you conducted. I would imagine that in at least some of those cases you have participants that are doing for themselves or opting for a target-date fund that are making regular contributions, so perhaps it gave you an opportunity to control for that factor. What did you find?

Clark: I would say there were two things that we find. You're right, when you look at target dates, within the industry, the vast majority of those assets--and it's a good thing--for many employees out there, the bulk of their savings is really coming from their 401(k) plans. So, when you look within the target-date industry, the bulk is coming from these 401(k) plans where they are doing these perpetual regular investments based upon their salaries. And what we find is that they're benefiting from the old term "dollar-cost averaging." They're tending to buy less in when the markets are high; they're tending to buy more when the markets are down. And so, they're having that benefit that is coming from just those regular incremental contributions.

Another thing we saw is that target dates actually change employees' behavior. That is a wonderful thing. So, I had a discussion--I always gave him credit. Professor [Bill] Reichenstein who was at Baylor University, we had done some presentations together, we were working together. He was really helping me understand and get an understanding of behaviors. I really wanted to understand my investors that were in my product area. And he said, "Jerome, it's all about packaging." He simplified it for me. When you look at a typical target date, and at the time, we had 18 underlying strategies, highly diversified. I said, let's just make it real simple. Just consider a portfolio that has 50% equity, 50% bonds. If an individual, let's say Bill, has two different investments in those portfolios, two different portfolios, one equities, one bonds, in an environment such as 2008, or the early 2000s, those bear markets, when they are getting that statement about their equity portfolio, that's what makes them panic when they see that singular focus on their equity component, which is getting double-digit negative returns. If they're going to act, that's the thing that's going to make them react and it's going to make them react typically in the wrong direction.

If you repackage that same savings, 50% equities, 50% fixed income, you package it together and now it's one statement that's coming, and you're just getting a return for your overall portfolio. When they're looking at these double-digit negative returns and they're getting much smaller either negative returns or even some of those years in the early 2000s where it's a little bit positive, while the market was pretty negative, the benefit of the diversification, that repackaging from fixed income, changes their behavior to their benefit and they're less likely to act. We find investors outside of target dates are 4 times more likely to make a move than those that are inside of target dates. And that is to the benefit of those that are invested in target-date products.

Benz: Switching over to matters of portfolio construction, "to versus through" is one of the most misunderstood concepts in the target-date fund universe. Explain what that is, why it matters, and how T. Rowe Price approaches it?

Clark: It's a confusing term because there are different ways that they are looked at. I try to put it in terms of thinking of higher-equity approaches versus low-equity approaches. What you find is because philosophically "through products" are focused on getting an investor through a long retirement, they tend to have higher equity allocations. When you look at a "to product," philosophically is to get an investor to retirement, so the horizon is shorter. And because the horizon is shorter, what you find is that they tend to have lower-equity strategies for investors in those products. That's how I generally couch the two. Sometimes folks refer to the shape. I don't subscribe to that. I think of it more in terms of "to versus through," higher equity versus lower, getting through retirement versus getting to.

Ptak: What are the implications of "through," or if you prefer "high equity"? Is it that target-date funds, as you mentioned, hang on to sizable equity allocations up to and through the target retirement date? So, let's talk about that and how it might intersect with an investor's risk tolerance. Let's suppose that for me the target date is really my retirement date. I'm done and I'll start drawing down from that point. Is the target-date fund with that date the right choice for me, or should I be looking at a fund that is a target date that's actually ahead of my target date?

Clark: I would say yes and yes. It depends on the investor. For those investors that when they look at their allocation, one of the big benefits we're getting right off the bat is that they're highly diversified. So, that is a really good thing. And they tend to be more appropriately away from these extreme behaviors that I talked about earlier. So, I would say an investor is never wrong if they conclude based upon their risk tolerance, that because they have a high risk tolerance, that they may be comfortable going out farther on that risk/return spectrum. I would say that's not an inappropriate thing to do. And at the same time, if as an individual or if as a plan you conclude for you or for your plan that you have a lower risk tolerance and less comfort with market volatility and so you want a lower equity allocation, I would say that it would not be inappropriate for you to utilize a less conservative or older-dated vintage target-date product. Now, that being said, what we find is the vast majority of those that are in target-date products are in the vintage that is designed for the age that they are.

Benz: Let's suppose I'm not retiring right on the target date. I might keep working for a few more years, and then I'll stop and begin drawing down. It seems like this is a really critical juncture. We saw that in stark relief in the first quarter where sequence-of-return risk can matter a lot. So, how do you determine that the additional equity exposure associated with a "through" glide path, and the sequence-of-return risk that accompanies it, is worth the potential upside?

Clark: I love that question. And the reason I love it is because many times what we talk about when it comes to sequencing risk is, point in time. So, I'm at retirement, if I look at my sequencing risk going forward, it can – a higher equity approach can seem like, you could question, is this a prudent thing to do given my vulnerability of losing principal in a down equity market? What we have to remember is that we just don't suddenly get to retirement and then we're investing at that allocation. If you're in a target-date glide path, you've been on a strategy that has been moving you towards this higher equity at retirement.

So, for example, the 2008 market. When you look at, for example, our 2010 fund, in the 2008 market, you're approaching retirement, and at retirement we're known for having a higher equity allocation. And sure enough in the 2008 market environment, our 2010 fund had a higher loss than the average target-date product. Ours was approximately minus 26% versus a minus 22% for the average target-date product out there in the marketplace at the time. But what we have to remember is what led us up to that point in time. We tend to become myopic in a bear market. And we focus on what's happening here and now. And we have to remind ourselves to be holistic, more holistic, and think about what is happening not only in that bear market, but up to it, and what tends to happen afterwards.

And if you look at our 2010 fund, though it had a higher loss in that downturn, what you found is that if you've followed us from inception, because of good markets that occurred leading up to that market--we launched it towards the end of 2002--2003 was a good market, '04, '05, '06, and part of '07. Those markets contributed to a disparity where we had a higher balance. But when you experienced that 2008 market, though we had the greater loss, what we saw is relative to the average target-date fund provider out there, with our higher-equity approach, with a larger loss in that environment, we still had a higher balance for that participant, so they were never any worse off. And then what I always remind our investors is that you have to keep in mind that bear markets tend to be preceded by good markets. And within the equity markets, there is a correlation that doesn't exist in the equity-and-cash world, and that is that the more significant the bear market we experience, the more significant tends to be the bull market that follows. And you know, they refer to 2008 as--we hope--a once-in-a-lifetime event, but then look what followed was basically what we might call close to a once-in-a-lifetime event when it came to the bull market that followed behind it.

Ptak: How globally adaptable is your approach to portfolio construction, specifically glide path construction? For instance, if you tried to apply the methodology you utilize in the U.S. and other markets, do you think you'd arrive at the same optimal portfolio construction, in your view? If not, what are some of the other factors that need to be considered, including, I would imagine, home-country bias is one of the things that one would need to factor in as well as maybe savings rates in a particular market. You tell us, though. What are some of those factors that would come into play?

Clark: Sure. First off, just to give some background, we have continually evolved our global allocation, and it has increased over the years. We started off when we launched a product in 2002 at a 15% allocation. Really interesting. It sounds like a small amount now. It actually is a small amount relative to your typical target-date products out there. But it was a different world back then. And the acceptance of international equities was much less than it is now. So, eventually, we moved to a 20% allocation. And a few years ago, what we did is we moved to a 30% allocation. Our analysis shows us that when you look at the trade-offs between domestics and internationals, anywhere between 30% and 40% tends to be the sweet spot for diversification. Because once you get out past 40%, the benefits of diversification--where they tend to offset each other--tend to fall off, and you're not getting any extra return. So, we think the sweet spot to be in a target date when it comes to our U.S. target-date products is to be in that 30% to 40%.

When you consider other markets and creating asset-allocation products or target-date products for investors in other countries, you can get to a different allocation based upon the circumstances of the individuals. There is absolutely a home bias. We actually manage a target-date product that is outside the U.S. We anticipate we'll be doing more of that in other countries. When we are developing the portfolio construction, we take into account the unique circumstances for those investors in those countries, which ends up in a different portfolio construction. What we found is because of life expectancies and various other factors--savings, the savings programs--it was for the Korean market, and we actually found that a glide path that was basically the same as ours, similar to ours, was really appropriate, but the portfolio construction could be different. So, I would say, I would not anticipate ever designing a product for another country that would not have a different portfolio construction, but depending on the circumstances, we may find so many similarities when it comes to those considerations for a glide path or a strategic asset allocation approach, they may be more similar than different.

Benz: One thing target-date funds don't have is the ability to customize them. They're an off-the-shelf product. Some people argue that that customization, such as what you would get through a managed account, is important enough to make opting for the managed account better than the target-date fund. What should a participant who is confronted with that fork in the road, maybe they have a target-date fund or a managed-account option, what should they think through when making that choice?

Clark: So, we subscribe to you want an appropriate asset-allocation strategy, not the right one. We don't say we have the right one. What we think is we have a prudent, appropriate glide path for participants. That being said, when you break down the journey of an individual through accumulation, when they're employed, and then retired and now they're decumulating, I would say that we've kind of found the holy grail when it came to accumulation with target dates. They are highly adopted by plan sponsors, highly adopted by participants. I don't think anyone feels that they're not doing a good job of getting participants to retirement because of the various different benefits we talked about in earlier questions.

When you get to retirement, we become less similar than we are different. And I say when you're doing accumulation, we're more similar than different. But then when you switch over and now you're going to retirement, there are some unique circumstances that come into play. Spousal assets, tax rates depending upon where you live, how much you the individual have saved, what is your income. What we find is that it can be quite challenging for those that have higher incomes because Social Security provides a smaller percentage of their retirement income. And because they have quickly, or maybe more quickly, changed their income level, those early contributions when their salaries tend to be low, contribute less to the benefit of retirement income.

So, there is some, I would say, good rationale for why in accumulation you might, if you have certain circumstances, be better served by a managed account. It might be a better solution for some individuals. That's why we're seeing it in the industry, and one of the things I'm focusing on, is this product area, new product area, that is growing is smart QDIAs. And I kind of think of it as a marriage or a partnership between a target date and a managed account. The target date serves a purpose of getting the individual to or close to retirement. And then as they approach retirement, it moves from just utilizing something based upon age, to take into account other considerations, other specifics to that individual and to account for some of the things I named--how much they've saved, what's their income level, those types of things--and giving them something that is more personalized to that individual based upon those additional considerations.

Ptak: And QDIA stands for qualified default investment alternative for our listeners who aren't familiar with that term. Jerome, you had mentioned income. And so, it seems like a logical next place to go is to ask why haven't fund companies been able to devise the equivalent of a target-date fund for income. Income spending and orderly drawdown still seem like a really complex process. Is there a way to simplify that, the way the target-date fund has done for investors who are in the accumulation phase?

Clark: I would say the challenges of simplifying it are going to be quite challenging. I had mentioned that we kind of found the holy grail when it came to accumulation. It was easier to do because, as I mentioned, accumulators are more similar than different. Because we're more different than similar when it comes to the decumulation, that makes it more challenging to identify a product, an offering that is going to satisfy the vast majority of individuals. That's one reason.

The other challenge is that I think the next successful product is going to be reliant upon a really good engagement model. I'm talking about a tool, a process that really does a good job of addressing the concerns and needs of an individual that's approaching retirement. Years ago, when we were thinking about offering target dates, we hired a firm, a consulting firm, and from those questionnaires I'll never forget one of the takeaways is that employees can feel lost--they feel very well taken care of by plan sponsors getting them to retirement, but they feel lost going into retirement. And that's why we see a high percentage of them that actually end up using an advisor, someone they could sit across the table from, can ask their questions, can bring them a level of comfort in moving into the retirement phase. Think about the challenge of that within a 401(k) plan. How do you replace that advisor? You have to have an engagement model that does a really good job of addressing those concerns. Without that, I don't think you have a successful retirement product. And even if you find successful retirement products, because we're more different than similar, at least our belief at T. Rowe Price, is that you have to have myriad options to address the varying needs of those participants who are now moved into retirement.

Benz: When it comes to retirement decumulation, would you say that a service is going to be the only way to do it that it's something that cannot be productized?

Clark: I would say that it could be. Because I believe it's going to be myriad things that are going to have to satisfy the various needs, I actually mean that in the terms of not just different products, but it could be in the form of some type of service versus a product, it could be a combination of the two. I think those things are to be determined. But I don't think any of those are off the shelf. I think it's going to be yes to all of that to satisfy the really wide range of needs we find for those individuals in retirement, not just needs, but circumstances.

Ptak: I wanted to turn quickly to fund selection, and maybe we can talk a little bit about sort of the overall efficacy of target-date funds and whether it's working. But before we get to that, as a target-date fund manager, how cognizant are you of the increasing importance of target-date fund flows to the underlying funds? For instance, where might capacity of an underlying strategy enter the equation, and do you consider the susceptibility of certain types of strategies to asset bloat or capacity constraints when you're making choices for your target-date fund lineup?

Clark: Capacity is always a consideration for most target-date providers. I think that you would be hard-pressed to find a major target-date provider that has not been surprised at the level of assets and the success of target dates. We were one of the very early entrants into the target-date space, and within two years, I was shocked. I'm always kind of overwhelmed by the continued success of this product area. That creates a lot of demand and a lot of assets in those underlying funds. Because of that, what we identified we needed to do very early on is form basically a task force to focus in on specifically capacity of our underlying components. And that's why you find that what we did is we reserved capacity, and we did that by instead of waiting until capacity might become an issue or did become an issue, we started closing our funds early by being very conservative in really how much we could potentially be getting. We wanted to not be surprised, caught off guard, by future cash flows once we realized how much prominence these products were going to have in the marketplace.

The other way that we have been able to address it is capacity is--there's two components of it--how much you have and what is the flow rate. What you don't want--what could hurt an underlying fund manager--is to have a lot of assets move in or a lot of assets move out. What we find is that for our underlying fund managers, actually a higher percentage of assets are coming from target date. What they have found is that actually makes it an easier proposition to manage those assets because they're more predictable. We talked early on about the incremental contributions that you see from target dates. They are pretty reliable, pretty predictable. And you don't have this fast money in and fast money out that you might experience outside of a target date to the detriment of other investors that are in those product areas. Target dates provide some stability to cash flows that benefits the target-date investors themselves and others that are within those underlying strategies.

Ptak: Let's turn to efficacy, whether it's working. How do you evaluate the efficacy of target-date funds in retirement plans? The performance of the underlying funds is surely important, as are choices you've made regarding the asset allocation. But are you also considering the way participants are using the funds and estimating the kind of dollar-weighted returns they're earning compared to the funds' total returns?

Clark: Every aspect of the design of our product is more focused on two things: long-term outcomes and the long view. So, what you just mentioned, performance--things such as short-term performance, tracking error, Sharpe ratio--those things are important, but from our perspective, they are not as important as focusing in on long-term outcomes. And we do this by focusing on three metrics: What are the account balances at retirement? What type of design gets you to the highest account balances? Because no matter what your behavior is in retirement, the higher the account balance, the better tend to be your outcomes. What is your probability of having your monies last a long time? And what is the residual wealth that you tend to have? In other words, how much do you tend to have as you go through retirement relative to other different approaches or designs, which one gives you the highest? Because what we find is that the higher your residual wealth, the better prepared you are for surprises, such as an unexpected spending shock in retirement, such as an unexpected medical bill or a car repair. What we find is about 70% of retirees have at least one spending shock throughout their retirement.

Ptak: Do you possess the data that's needed to make the assessments for each of those three metrics that you mentioned? And if so, I guess what gives you confidence that the approach that you're taking is yielding success and readiness for participants who are investing in your target-date funds?

Clark: Well, I had mentioned earlier on about we did this more sophisticated Monte Carlo analysis. Fast forward to today. And I had mentioned the gentleman Jim (Tessoro), we had worked together while I was focused on historical analysis. The historical analysis is very similar to what we did back then. It's relevant. But when it comes to the forward-looking, more sophisticated Monte Carlo analysis, we actually laugh about what was sophisticated then is so antiquated now. Jim has a team of individuals--our whole research team has grown from Jim by himself to 20-plus individuals working within our research group. The modeling, the information that we've been able to gather, are much more advanced than they were. That gives us a much higher level of conviction with what the model tells us. And what the model tells us is that small changes or increases in equity allocations can have really meaningful impact to the outcomes for individuals with minimal impact to their short-term volatility. And that's why we've actually, this year, announced and have started the process of making changes to our glide path, particularly on the front end and the back end, where we're making modest equity allocations based upon, one, our modeling; two, the historical analysis that we did to affirm it; and three, going out to the marketplace and socializing and making sure the marketplace was prepared and ready for the changes. We incorporated these enhancements into our glide path.

Ptak: When you talk to the marketplace, how do you mitigate against the risk that some of the sponsors and some of the participants that you might be interacting with have gotten a bit complacent about equity risk? Just because equity markets have been so good to them for the past decade-plus maybe they are more amenable to adding a bit more equity to certain of the funds in the series for the simple reason that equities have been so good. Is that a conversation that goes on, and how do you make sure that they really want it?

Clark: One, we do find some of that, and that makes it really critical to be very proactive to talk about the potential downsides to that. The one thing I learned in the 2008 market environment is that, if I had one regret about it leading up to it, is that me and my team didn't do as good a job of talking about the potential downside in that type of market environment. And I made a commitment to myself and my team that we would always, going forward in the good times, really focus and make sure that we were being prudent with our investors. So make sure they understood the other side of the equation, while they are enjoying these good returns, this historical bull market that we've been experiencing, making sure that they are staying holistic and remembering that these good times will be followed by not-so-good times as it always has happened historically and will occur going forward. And so, we were very proactive and making sure we communicated not just the potential benefits of the changes we're doing but the potential downsides of that. And making sure they understood the trade-offs.

The other thing is there are very few plan sponsors now who move forward in a target-date space without the help of an intermediary, an advisor, or a consultant. And they are absolutely zoned in on the potential downsides as well as the upsides. They are not complacent about the bull markets that we have experienced. And B, forthright and forthcoming with them, our enhancements were very well received by advisors, consultants, and planned sponsors.

Benz: When you think about asset allocation, is there kind of a convention of asset allocation, something that everybody falls back on that you think has maybe outlived its useful life. And also sort of the flip side of that, is there a nut to crack within the asset-allocation space that you think is really important and the industry really hasn't done it so far?

Clark: I would say the times have changed dramatically over the 17 years that we've been offering target dates, but we've been doing it much longer than that with other asset-allocation products. I would be hard-pressed to find things that are not useful anymore when it comes to target dates. When you think about the asset-allocation strategy, the diversification benefits, the taking it out of the hands and putting in an investment professional, I just find it hard to find those things that asset-allocation products have outlived.

As far as what's not been cracked yet, I would say retirement income because of those things I was talking about, about our differences and the myriad programs. There is not a target-date provider that is not trying to figure out how to incorporate retirement income, but the challenges have been pretty daunting, though we keep hammering away at it. And then the other thing is smart QDIAs, things like costs, things like a really good engagement model have made it challenging. We haven't cracked that yet. The anticipation is that we will figure out a way to do it as it going to really benefit investors out there in the marketplace.

Ptak: This has been wonderful. Thank you so much for your time and insights today. We really appreciate them. I know that our listeners will find them very useful. So, thanks again for taking the time for us.

Clark: All right, thank you. I really appreciate it.

Benz: Thank you, Jerome.

Ptak: Take care.

Clark: Take care. Bye.

Ptak: Thanks for joining us on The Long View. If you liked what you heard, please subscribe to and rate The Long View from Morningstar on iTunes, Google Play, Spotify, or wherever you get your podcasts.

Benz: You can follow us on Twitter @Christine_Benz.

Ptak: And at @Syouth1, which is, S-Y-O-U-T-H and the number 1.

Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.

(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. Morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Jeff Ptak is an employee of Morningstar Research Services LLC. Morningstar Research Services is a subsidiary of Morningstar, Inc. and is registered with and governed by the U.S. Securities and Exchange Commission. Morningstar Research Services shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis or opinions or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decision.)