Retirement Insights

Fund Scoring Systems: Do They Measure What Matters?

Fund Scoring Systems: Do They Measure What Matters?

As of September 30, 2022

The recent market turbulence underscores the importance of having a thoughtful, well diversified asset allocation plan appropriate for each stage of the retirement journey, especially for plan participants near or early into retirement. With declines across nearly every asset class, sector and geography, there has been almost no place to hide in 2022 thus far. In our view, a thoughtfully constructed retirement plan requires being able to select from a diverse lineup of investment options appropriate for all types of market conditions and macroeconomic regimes.

We believe that plan sponsors need to focus on how retirement wealth accumulates and compounds at the participant level when selecting investment plan lineups. In our view, scoring systems that use historical returns to evaluate manager performance do not accurately capture how regularly scheduled contributions compound over time and are impacted by volatile market conditions. Furthermore, historical returns do not consider how regularly scheduled contributions incorporate the benefit of dollar-cost averaging as portfolios potentially compound in volatile investment environments or how sequencing risk impacts wealth when account balances are larger and may take longer to recover deficits. As a result, scoring systems may lead to a false impression of how wealth is created by omitting these aspects of participant experiences. With a more detailed and nuanced understanding of how wealth accumulates at the participant level, plan sponsors are better able to build a menu of investment choices that help enable participants to achieve retirement goals and preserve wealth through capturing market upside while providing downside mitigation across disparate economic regimes.

Key Takeaways

  • We believe that a thoughtfully constructed retirement plan begins with a diverse lineup of investment options that is appropriate for all types of market conditions and macroeconomic regimes. In our view, plan sponsors need to consider how retirement wealth accumulates and compounds at the participant level when building a menu of investment choices.
  • Scoring systems that focus on historical returns do not accurately capture how regularly scheduled contributions compound over time and the impact of volatility. Historical returns do not consider the benefit of dollar-cost averaging in volatility. Historical returns do not consider the benefit of dollar-cost averaging in volatile market environments or how sequencing risk impacts wealth when account balances are larger and may take longer to recover deficits.
  • By focusing on how funds perform on the participant level, plan sponsors are better able to select plan lineups that are able to potentially capture market upside while providing downside mitigation across disparate economic regimes.

"Lies, Damn Lies and Statistics"

As popularized in the U.S. by Mark Twain (among others), the phrase “Lies, Damn Lies and Statistics” describes the persuasive power of statistics to bolster weak arguments. As part of their due diligence efforts, most sponsors and their advisors employ scoring systems to streamline the evaluation of the large number of investment strategies available in the marketplace. To select a lineup of investment options and monitor their ongoing suitability, these systems typically use a strategy’s historical returns to calculate a range of performance metrics, which are then compared to their peer universe and/or benchmarks. While we recognize that fund scorecards represent an easy, scalable way for plan sponsors to compare a large selection of funds on a somewhat apples-to-apples basis, the approach is not without its flaws. Perhaps most notably, it often fails to accurately capture how retirement wealth accumulates over time at the participant level, thus obscuring the investment vehicles best suited to support it.

As a rough illustration, let’s consider the average annual return of the MSCI EAFE Index versus the First Eagle Overseas Fund (Class R6 shares). As shown at the top of Exhibit 1, the fund lagged the index in four of the past five full calendar years beginning in 2017. Even with its strong outperformance in year-to-date 2022, the fund has trailed by an average of approximately 50 basis points annually, which would seem to make it a less than ideal option for international equity exposure. However, this methodology fails to account for the significant difference in volatility between the fund and index—11.13% and 15.84% respectively—and the impact that has had on wealth accumulation over time.1

The bottom of Exhibit 1 depicts that same return data in a way that captures that volatility and more closely resembles the experience of long-term investors like retirement plan participants, whose multiple contributions over time create different entry prices into investments and position them to potentially benefit from the power of compounding. When considered from this perspective, the Overseas Fund had a total return more than 400 basis points higher than the index, meaning that that $10,000 contributions on January 1 of each of these years would result in nearly $2,500 of downside mitigation.

Exhibit 1. Annual Return Data Tell an Incomplete Story

Annual Return Data Tell an Incomplete Story

Source: Bloomberg; Morningstar; data as of September 30, 2022. This chart illustrates a hypothetical investment in Class R6 shares and assumes all distributions have been reinvested. Date selected assumes purchase on the first day of the year. A contribution of $10,000 is made each year on January 1 in 2017, 2018, 2019, 2020, 2021 and 2022. For example, A $10,000 contribution or investment in the First Eagle Overseas Fund made in 2017 would grow to $10,715.73 as of September 30, 2022.

Hitting for Average

Among the potential benefits of the defined contribution structure is that it effectively compels plan participants to utilize dollar-cost averaging (DCA), an investment technique that may help mitigate the impact of markets’ short-term volatility while benefitting from their tendency toward long-term appreciation. By allocating a set dollar amount on a recurring basis (typically per pay period) over time and across disparate market conditions, participants accumulate units of the various investment products comprising their retirement account at different price points, buying more when prices are lower and fewer when prices are high. This may result in a lower average price per unit for a given investment and possibly facilitate greater appreciation over time.

As illustrated in the previous exhibit, dollar-cost averaging also means the investment performance of plan participants often diverges—sometimes significantly—from the reported performance of their investment options and the indexes they are benchmarked to. This mismatch can have unintended consequences for sponsors seeking to build and monitor their investment lineups.

Mitigating Downside Risk to Amp Up Effects of Compounding

At the end of the day, what matters to plan participants in general is not the annualized return of their investments, but rather the nest egg that is built over time. This is where compounding comes in, which was described by Albert Einstein as “the eighth wonder of the world.” Given their extended investment horizon, retirement portfolios are particularly well-suited to compounding. That said, highly volatile portfolios—i.e., those that experience large swings to the upside and downside—are inefficient vehicles through which to compound wealth over time. Simple math bears this out; a portfolio must generate a gain of 100% to recover from a 50% loss, but a gain of only 33% will get you back to breakeven from a 25% decline.

Exhibit 2 provides another perspective on historical volatility, using the S&P 500 Index to showcase the sharp changes that can happen both from year to year as well as within calendar periods. While steep declines are always a headwind to long-term wealth accumulation, in a worst-case scenario they may result in the permanent impairment of capital. This is a particular risk when losses occur late in a participant’s lifecycle, when account balances are larger and time to recover deficits is shorter (aka, sequencing risk).

Exhibit 2. Volatile Equity Markets Can Be a Challenge to Retirement Savers

Volatile Equity Markets Can Be a Challenge to Retirement Savers

 

This volatility is why we believe that minimizing losses is the key to harnessing the power of compounding and mitigating sequencing risk. First Eagle seeks to avoid the permanent impairment of capital by carefully managing our downside exposure while potentially participating in market upside.

For retirement savers, in particular, the benefits of such an approach are perhaps best illustrated through an analysis of rolling returns; by capturing multiyear performance in overlapping cycles that begin each month, rolling returns more closely resemble the non-calendarized timeline of the typical investor. In Exhibit 3, we compare the long-term performance of the First Eagle Overseas Fund (Class A shares) against several prominent indexes over rolling three-, five- and 10-year periods dating back to August 1993. The Fund has not posted negative returns for any five-or 10-year period and far fewer three-year negative periods than the indexes. As a result of this all-weather performance, it generated a cumulative gain of more than 1,100% during the period compared to 260% for the MSCI EAFE Index.

Exhibit 3. First Eagle Overseas Fund Seeks to Consistently Mitigate the Impact of Market Downturns
August 1993 through December 20212

OVS Fund Seeks to Consistently Mitigate the Impact of Market Downturns
Source: FactSet; data as of December 31, 2021.

Gaining Ground by Standing Still

In the decades since the emergence of defined contribution plans and their subsequent ascension to being the primary savings vehicle for the American worker, inertia has been viewed as among the primary obstacles to retirement readiness. Attempts to overcome this tendency led to the introduction of a number of innovative solutions—such as auto-enrollment and auto-escalation—that have improved participation and savings rates, most notably since the Pension Protection Act of 2006 went into effect.

Ironically, this same inertia may prove beneficial to less-engaged plan participants during difficult markets, as a consistent “set it and forget it” contribution strategy may help them avoid some of the emotionally driven investment decisions—panic selling in the face of falling markets, for example—that can be a hindrance to successful outcomes in retirement.

Of course, tough times serve as a reminder to plan sponsors and their advisors that participants need thoughtful, well-diversified portfolios appropriate for all stages in the retirement journey, a need that can potentially be met by constructing investment lineups of varying styles, philosophies and goals that are complementary across macroeconomic regimes. We believe this begins by mapping long-term strategy outcomes against the shifting market conditions in which plan participants will put money their money to work.

For professionals and participants alike, we believe a thoughtful strategy consistently applied may be a valuable approach to attaining retirement readiness. In our opinion, managing market risk and volatility begins with building differentiated investment portfolios that attempt to reduce short-term volatility and limit downside capture, which in turn would likely encourage participant adherence to long-term plans and promote the steady compounding of assets in real terms over time. Retirement plan sponsors can support this endeavor by providing a lineup of strategies with complimentary styles, philosophies and goals that together are appropriate across myriad market conditions.

Related Insight

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  1. FactSet; data as of September 30, 2022.
  2. Note: The Fund commenced operation on August 31, 1993. Performance for periods prior to January 1, 2000, ocurred while a prior portfolio manager of the Fund was affiliated with another firm. The date shown reflects when this prior manager assumed portfolio management responsibilities. Values would be lower if a sales charge was included and assumes all distributions have been reinvested. Please see end of the document for the dates for the worst rolling periods.

 

Avg Annual Returns

The performance data quoted herein represent past performance and do not guarantee future results. Market volatility can dramatically impact a Fund's short-term performance. Current performance may be lower or higher than figures shown. The investment return and principal value will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Past performance data through the most recent month-end are available at www.firsteagle.com or by calling 800-334-2143. The annual expense ratio is based on expenses incurred by the fund, as stated in the most recent prospectus

This material is for informational purposes only and is not to be construed as specific tax, legal, or investment advice. You are strongly encouraged to consult with your independent financial professional, lawyer, accountant or other advisors as to investment, legal, tax and related matters.

The opinions expressed are not necessarily those of the firm and are subject to change based on market and other conditions. These materials are provided for informational purposes only. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice. Any statistics contained herein have been obtained from sources believed to be reliable, but the accuracy of this information cannot be guaranteed. The views expressed herein may change at any time subsequent to the date of issue hereof. The information provided is not to be construed as a recommendation or an offer to buy or sell or the solicitation of an offer to buy or sell any security. The information in this piece is not intended to provide and should not be relied on for accounting, legal, and tax advice.

Risk Disclosures

All investments involve the risk of loss of principal.

There are risks associated with investing in securities of foreign countries, such as erratic market conditions, economic and political instability and fluctuations in currency exchange rates. These risks may be more pronounced with respect to investments in emerging markets.

Investment in gold and gold related investments present certain risks, and returns on gold related investments have traditionally been more volatile than investments in broader equity or debt markets.

The principal risk of investing in value stocks is that the price of the security may not approach its anticipated value or may decline in value.

Diversification does not guarantee investment returns and does not eliminate the risk of loss.

Dollar-cost averaging involves investing the same amount of money in a target security at regular intervals over a certain period of time, regardless of price.

Upside capture is the ratio of a fund's overall return to global equity market returns evaluated over periods when equities have risen.

Downside capture is the ratio of a fund's overall return to global equity market returns evaluated over periods when equities have fallen.

Volatility is a statistical measure of the degree to which an individual portfolio return tends to vary from the mean, based on the entire population. The greater degree of dispersion, the greater degree of risk.

Indexes are unmanaged and one cannot invest directly in an index.

Rolling Returns is a measurement that tracks returns with more frequency. A five-year average annual return provides a measurement for a single time period. A rolling five-year average annual return will begin a new time period at the beginning of each month, providing 12 separate time periods for each calendar year in the measuring period. The dates for the worst 3-year rolling period are: Overseas Fund: 4/2006–3/2009; S&P 500 Index, MSCI World Index and MSCI EAFE Index: 4/2000–3/2003. The dates for the worst 5-year rolling period are: Overseas Fund: 6/2007–5/2012; S&P 500 Index: 3/2004–2/2009; MSCI World Index: 4/1998–3/2003; MSCI EAFE Index: 6/2007–5/2012. The dates for the worst 10-year rolling period are: Overseas Fund: 5/2007–5/2017; S&P 500 Index, MSCI World Index and MSCI EAFE: 3/1999–2/2009.

Standard & Poor's 500 Index is a widely recognized unmanaged index including a representative sample of 500 leading companies in leading sectors of the U.S. economy and is not available for purchase. Although the Standard & Poor's 500 Index focuses on the large-cap segment of the market, with approximately 80% coverage of U.S. equities, it is also considered a proxy for the total market.

MSCI EAFE Index is an unmanaged total return index, reported in U.S. dollars, based on share prices and reinvested net dividends of companies from 21 countries and is not available for purchase.

MSCI World Index is a widely followed, unmanaged group of stocks from 23 developed markets and is not available for purchase. The index provides total returns in U.S. dollars with net dividends reinvested.

Investors should consider investment objectives, risks, charges and expenses carefully before investing. The prospectus and summary prospectus contain this and other information about the Funds and may be obtained by visiting our website at www.firsteagle.com or calling us at 800-334-2143. Please read our prospectus carefully before investing. Investments are not FDIC insured or bank guaranteed, and may lose value.

FEF Distributors, LLC (Member SIPC) distributes certain First Eagle products; it does not provide services to investors. As such, when FEF Distributors, LLC presents a strategy or product to an investor, FEF Distributors, LLC does not determine whether the investment is in the best interests of, or is suitable for, the investor. Investors should exercise their own judgment and/or consult with a financial professional prior to investing in any First Eagle strategy or product. First Eagle Investments is the brand name for First Eagle Investment Management, LLC and its subsidiary investment advisers.

The First Eagle Funds are offered by FEF Distributors, LLC, a subsidiary of First Eagle Investment Management, LLC. First Eagle Investment Management, LLC provides advisory services.

First Eagle Investments is the brand name for First Eagle Investment Management, LLC and its subsidiary investment advisers.

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