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JPMORGAN ASSET MANAGEMENT WHITE PAPER FINDS CRITICAL FACTORS HAVE BEEN OVERLOOKED IN THE DESIGN OF SOME TARGET DATE FUNDS

Mar 19, 2007

New York, March 19, 2007 - Given that target date funds (“TDFs”) are likely to become the most popular default option once the Department of Labor (“DOL”) draft regulations issued in September 2006 become effective, a white paper released by JPMorgan Asset Management (“JPMAM”) today, entitled “Ready! Fire! Aim? ”, presents findings on how some TDFs are missing the mark on providing retirement security to those who need it most.

The white paper proposes a prudent goal for both plan sponsors and participants and illustrates how standard industry assumptions of saving and investing are oversimplified, why the incorporation of actual participant saving and spending behavior matters in designing and evaluating target date strategies and finally, compares the effectiveness of four industry approaches to target date fund investing. In particular, the white paper looks at two important 401(k) issues for plan sponsors to consider when selecting target date funds for their participants:

• how realistic is the fund industry’s modeling of participants’ savings and spending patterns (looking at the saving and spending habits of 1.3 million 401(k) participants whose accounts are administered by JPMorgan Retirement Plan Services*)?
• what target date portfolio design will best stand up to the stresses of real life saving and investing?

White Paper Findings:

Objectives for Plan Sponsors:
 The white paper recommends that each plan sponsor needs to explicitly define their objective in providing a default target date strategy for participants. The paper suggests that a prudent objective is to help as many participants as possible achieve their income replacement goal at retirement. This is a measurable goal with a known time horizon (from date “hired to retired”), as opposed to a life long investing program (from “graduation to grave”), which may not be appropriate for many plans as it extends the investment horizon into an unknowable future where cash flows are likely to vary tremendously. Success for the retirement income security goal is defined by the proportion of participants that arrive at retirement with 401(k) savings sufficient to purchase (whether they choose to or not) a lifetime annuity replacing approximately 40% of their working income (i.e. half of the 80% of working income required in retirement and not provided by Social Security).

Oversimplified industry assumptions – participants’ savings behavior:
Conventional wisdom with regard to participant behavior (savings and withdrawal patterns) is fatally flawed, the white paper concludes. In reality, participants contribute less to their accounts, and borrow and withdraw more than assumed in other industry research. JPMAM researched the saving and spending behavior of its own JPMorgan Retirement Plan Services’ participant database of 1.3 million participants* (see key finding below) and found that real-world assumptions regarding participant saving behavior measurably reduced expected 401(k) balances at retirement.

• Current industry assumptions about pre-retirement are that participants do not borrow from their 401(k) plan and that premature distributions do not happen. JPMAM’s research* found that 20% of participants borrow on average 15% of their account balance. Fifteen percent of participants withdraw on average 25% of assets starting at age 59.5.
• At retirement, according to industry assumptions, participants withdraw smoothly 4-5% on an annual basis. JPMAM’s research found that the average participant withdraws over 20% per year at or soon after retirement.
• The assumption about contributions is that they start at 6%, increase year by year, reach 10% of salary by age 35 and remain at that level until retirement.  JPMAM’s research found that on average contribution rates start at 6% but increased slowly reaching 8% of salary by age 40 and 10% not until age 55. The distribution of contribution rates is wide. Each year, on average 10% of participants lowered or stopped contributions.
• The assumption is that all participants get a salary increase annually – JPMAM’s research found that on average, people get raises every two out of three years.

Volatility:
The white paper finds that volatility of cash flows in participant accounts (loans, withdrawals and contribution holidays as mentioned above) can amplify the effect of market volatility on retirement outcomes. The interaction of the two factors means many participants can be partially out of the markets during crucial years for building capital and this can have severe consequences on 401(k) balances of plan participants.

Target date portfolio design:
JPMAM argues that plan sponsors should focus most of their attention on 401(k) outcomes below the median expected account balance, i.e. participants experiencing the market events and savings behavior that put them at the greatest risk of not meeting their income replacement goals.  JPMAM suggests that the investment strategy for a 401(k) target date fund will have to compensate for volatility in terms of the contributions and withdrawals made by participants and the volatility in market returns.

JPMAM recommends that sponsors need to think beyond the ‘equity glide path’ which has become synonymous with overall return potential and expected risk or volatility in funds – and instead think in terms of an ‘asset allocation glide path’ which incorporates other asset classes into the mix – the combination of which can lead to similar expected returns, but with a more efficient use of risk.

Investing at controlled levels of risk generates more predictable investment results (than an undiversified mix high in equities) with a more concentrated dispersion of retirement saving, the white paper finds. Consequently, even participants with below average investment results have a better chance of meeting their income replacement goals at retirement.

Implications for Plan Sponsors:
JPMAM’s white paper emphasizes that the volatility in participant cash flows must be included in both the plan design and the evaluation of target date fund strategies. Sponsors evaluating comprehensive default strategies such as target date funds need to understand actual participant behavior and its implications for long run investing.

A broadly diversified portfolio that extends beyond conventional stocks and bonds to non- traditional assets (such as direct and public real estate, emerging market debt and equity, and high yield bonds) and brings to the individual participant the diversification and risk efficiency characteristic of sophisticated institutional portfolios, can lead to better income replacement - particularly for those participants who need it most, deems the white paper.

In JPMAM’s Monte Carlo simulations of a 10,000 participant population, under real life assumptions from the JPMAM participant research, the JPMAM SmartRetirement Strategy compares favorably to three other identified categories of fund design (referred to as Aggressive, Concentrated and Conservative) and shows higher 401(k) account balances at retirement for portfolios below the 50th percentile of possible retirement outcomes – the events that put participants at greatest risk of not replacing the crucial 80% of working income they will need in their retirement years.

 “We began this research project because we wanted to test the intuitive understanding of participant behavior that we had developed as record-keepers,” said Anne Lester, Senior Portfolio Manager, Global Multi-Asset Group, JPMorgan Asset Management. 
“We already knew that participants changed their contribution rates up and down, took loans, and took premature distributions.  And now we know that this behavior is having a huge effect on participants’ assets.

Lester added: “We had also developed a high degree of skepticism regarding the “one size fits all” design philosophy of target date investing that takes participants from graduation to grave.  We do think one size fits most – but only up to the point of retirement.  Furthermore, we believe that an appropriate fiduciary goal for plan sponsors is to focus on the objective of providing retirement income security - done by providing a broad base of participants with a target date investment strategy that performs well under many market conditions and one which gives participants below the median the best chance of income replacement in retirement. Institutional quality fund design with broad asset diversification is the right thing to do for DC participants – and we have been building portfolios like this at JPMorgan for over 25 years."

For a copy of the white paper please email:  jpmam.info@jpmorgan.com

Notes to Editors:
JPMorgan Retirement Plan Services:
*The white paper findings on participant behavior are based on the analysis of the JPMorgan Retirement Plan Services proprietary database of over 1.3 million participants, a representative sample of DC plan participants in the U.S. This covers 250 employers and 350 plans with participants from about 30 industries in over 36 states.  The average salary range for the group is $30,000-$70,000, with about 10% below $10,000 and 10% above $100,000. The analysis covers the period from 2001 to 2006.
The Global Multi-Asset Group:

The Global Multi-Asset Group has been managing multi-asset portfolios on behalf of institutional investors including defined contribution plans, defined benefit plans and endowments and foundations for over 25 years. The Group blends its capital markets, strategic and tactical asset allocation, portfolio construction and active risk budgeting capabilities with one of the broadest product offerings in the industry. JPMorgan’s variety of return sources extends across asset classes, geographies and proven investment methodologies.
This global product palette provides GMAG’s experienced multi-asset class investment specialists with access to the ideal, low correlation building blocks necessary for structuring efficiently diversified portfolios.

SmartRetirement:

SmartRetirement, the Global Multi-Asset Group’s target date strategies, provide defined contribution plan sponsors and participants with institutional quality investment solutions.

The JPMorgan SmartRetirement plan design includes investment strategies based on a targeted retirement date. The strategies with the longest time horizons, constructed for those in the early stages of their careers, hold a larger allocation in equity, putting more emphasis on capital appreciation and growth. Investment strategies with shorter time horizons have a greater allocation to fixed income, but maintain modest exposure to extended equity markets. The firm offers a range of target date strategies in 5 year increments: JPMorgan SmartRetirement Income, JPMorgan SmartRetirement 2010, JPMorgan SmartRetirement 2015, JPMorgan SmartRetirement 2020, JPMorgan SmartRetirement 2025, JPMorgan SmartRetirement 2030, JPMorgan SmartRetirement 2035, JPMorgan SmartRetirement 2040 and JPMorgan SmartRetirement 2045. The JPMorgan SmartRetirement strategies are a simple, one-time investment decision that adapts to the changing needs of participants as they approach retirement. 

About JPMorgan Asset Management:
With $1013 billion as of December 31, 2006*, in global discretionary assets under management, JPMorgan Asset Management is one of the largest active asset managers in the world and one of the largest mutual fund companies in the United States, providing institutional, ultra high net worth and retail clients with outstanding investment products across all asset classes globally, including fixed income, equity, liquidity, real estate, private equity and hedge funds. 
*Based on AUM for the Asset Management (JPMAM, PB, PCS) division of JPMorgan Chase & Co. as of December 31, 2006.
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Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The view and strategies described may not be suitable for all investors.
JPMorgan Asset Management is the marketing name for the asset management businesses of JPMorgan Chase & Co. Those businesses include J.P. Morgan Investment Management Inc., JPMorgan  Investment Advisors Inc,  Security Capital Research & Management Incorporated and J.P. Morgan Alternative Asset Management, Inc.