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Target date fund

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A target-date fund – also known as a lifecycle, dynamic-risk or age-based fund – is a collective investment scheme, usually a mutual fund, designed to provide a simple investment solution through a portfolio whose asset allocation mix becomes more conservative as the target date (usually retirement) approaches.

History

Target-date funds were first introduced in the early 1990s with BGI being the first institution to offer such products.[1] Their popularity in the US increased significantly in recent years due in part to the auto-enrollment legislation Pension Protection Act of 2006 that created the need for safe-harbour type Qualifying Default Investment Alternatives, such as target-date funds, for 401(k) savings plans. With the UK enacting auto-enrollment legislation in 2012, target-date funds will be used by NEST National Employment Savings Trust, and are expected become increasingly popular as their design should satisfy the DWP's eligible default fund criteria.[2]

Design

Target-date funds are aimed at people planning for retirement and have appeal because they offer a lifelong managed investment strategy so should remain appropriate to an investor's risk profile even if left accidentally unreviewed. Research suggests that age is by far the most important determinant in setting an investment strategy, thus Target Date, or age-based funds are particularly attractive as default investment funds.[3] They do not offer a guaranteed return but offer a convenient multi-asset retirement savings strategy through a single outcome-oriented fund.[4]

Target-date funds' asset allocation mix typically provides exposure to return-seeking assets, such as equities, in early years when risk capacity is higher, and becomes increasingly conservative as time progresses with exposure switched progressively towards capital-preservation assets, such as government- and index-linked bonds.[5]

The speed with which a target date fund de-risks its asset allocation is known in the industry as the "glide-path", using the analogy of an airplane (the fund, presumably) coming in for a landing (the landing being, presumably, arriving at the Target Date with the appropriately low-risk mix of underlying assets).

By taking a managed, or stochastic, approach to de-risking the fund, target-date funds offer a higher level of both technical and fiduciary care than earlier lifestyling techniques that rely on an automated, or deterministic, approach.[6][7]

The theoretical underpinnings to glidepath design are based on combining modern portfolio theory, with the theory of "Human Capital", the present value of expected future earnings.[8]

Controversy

The funds are not without their critics, who point to the unexpected volatility of some near-dated target-date funds in the financial crisis of 2007–2008, suggesting they were not as conservatively positioned as their name would imply.[9] In response to this, the SEC and DoL hosted a joint hearing on Examining Target Date Funds in June 2009,[10] which found that while target-date funds were generally a welcome innovation, disclosure had to be improved to ensure investors were fully aware of a target-date fund glidepath, which may differ from manager to manager. The rules on disclosures for target-date funds were published by the SEC in 2010.[11]

See also

References

  1. ^ Market Wire 7-Nov-08: Industry's First Target-Date Fund Celebrates 15 Years Since Groundbreaking Launch
  2. ^ DWP Guidance for offerang a default option
  3. ^ Alliance Bernstein: Target date funds explained
  4. ^ SEC Investor Bulletin on TDFs
  5. ^ Target Date Funds: will the UK follow the American revolution
  6. ^ Dynamic Lifecycle Strategies for Target Date Retirement Funds - Basu, Byrne & Drew (2009)
  7. ^ From Deterministic to Stochastic Life-Cycle Investing: Implications for the Design of Improved Forms of Target Date Funds - Martellini & Milhau (2010)
  8. ^ Ibbotson Associates Research Paper: Lifetime Asset Allocations: Methodologies for Target Maturity Funds
  9. ^ Target-Date Funds Go Under the Microscope
  10. ^ Ibbotson's reaction to the Joint SEC DOL Target-Date Fund Hearing
  11. ^ SEC Proposes New Measures to Help Investors in Target Date Funds
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