In the vast world of investment management, Target Date Funds (TDFs) have tectonically shifted the landscape, offering a simplified, passive investment approach tailored to a predetermined retirement date.
TDFs have grown enormously in assets, reaching $1.4 trillion at the end of 2019, and account for approximately 24% of all assets in 401(k) accounts.
The idea is simple: as the target date approaches, the fund’s asset allocation shifts, typically from a riskier to a more conservative profile. But as with all investment products, the ever-evolving financial landscape reveals the pros and cons of strategies playing out in real time.
While target-date funds aim to reduce risk overtime, they—like any investment—are not risk free, even when the target date has reached.
So is a Target Date Fund right for you?
New research suggests that TDFs have moved a significant share of retirement investors into macrocontrarian strategies that sell stocks after relatively good stock market performance. (Household portfolios and retirement saving over the life cycle; JA Parker, A Schoar, AT Cole, D Simester; National Bureau of Economic Research)
Is buying high and selling low the passive way to build long term wealth?
Let’s dive deeper into potential actions TDF managers could undertake to optimize their funds and reduce equity selling pressure:
Glide Path and Sub-Asset Allocation Adjustments
Investments look completely different depending on the period of time you invest according to the “glidepath”. A glidepath is quite simply the line, as it changes over time, between the risky asset and the reserve asset.
While it is widely known that the glide paths from different providers vary significantly, to date
very little has been written about the year-over-year changes in the glide paths of different
providers.
However, Vanguard, like every target-date manager, makes active decisions in determining the overall and sub-asset-class mix across the glide path. Since 2003, there have been five changes in glide paths and sub-asset allocations for Vanguard’s TDFs series.
Adjusting the glide path involves changing the rate at which the asset allocation shifts as the target date nears. Sub-asset allocation adjustments can mean a variety of things, from tweaking the proportion of equities versus bonds to refining exposure to specific sub-sectors or geographies.
Such adjustments can help in matching the evolving risk profiles and financial goals of investors, while also reducing undue market pressures. According to some asset managers, no credible rationale has ever been proffered for using a glide path in the distribution phase, which is the time you actually begin withdrawing from your retirement account.
TDF Mergers & Acquisitions
Upon reaching their target dates, some target-date funds merge into different funds that typically focus on generating income.
A good example of this is the protocol Vanguard adopts for maturing TDFs to be rolled into the Vanguard Target Retirement Income Fund.
Mergers can help in achieving economies of scale, streamlining the number of offerings, and ensuring investors continue to receive a return on their investments beyond the target date. This is know as investing “through” retirement, rather than “to” retirement.
For this reason, it’s important to read the fund’s prospectus to understand what the target date actually means and to avoid being surprised by how the fund’s asset allocation changes over time.
New Fund Creations
As time marches on, newer TDFs need to be created to cater to the needs of younger investors with farther-off retirement dates. For instance, a 2075 TDF would cater to individuals who are planning to retire around that year. But what determines the creation of a new TDF?
Is it possible that business profitability could take precedence over your retirement timeline? Often, fund managers consider factors like anticipated demand, the evolving financial landscape, and regulatory requirements when deciding the threshold for launching a new series.
Vanguard Big 4 Total Series: Starts at the top.
When assessing net inflows into TDFs, it’s critical to look at the right aggregate level.
The “Vanguard Big 4 Total Series” stands out as a meaningful in its structured designed.
(Vanguard Total Stock Market Index Fund, Vanguard Total International Stock Index Fund, Vanguard Total Bond Market II Index Fund, Vanguard Total International Bond II Index Fund)
Most of the TDF series hold these four funds.
This is largely due to fund managers’ inter-lending provisions allowed in the prospectus which allow for internal lending among the funds. By assessing net inflows at this aggregate level, one can gain a clearer understanding of the overall health and liquidity of the TDF sector.
In conclusion, while TDFs are often perceived as passive investment tools, the strategies adopted by their managers are anything but passive.
Through thoughtful adjustments, mergers, fund creations, and prudent benchmarks, TDF managers ensure that these funds remain resilient, adaptive, and attuned to the needs of their investors. The power of passive, it seems, lies in the active decisions made behind the scenes.
*Nothing in the above should be interpreted as an offer to sell investment securities, nor a
solicitation of an offer to sell or purchase investment securities.*