Target Date Funds are funds designed to dynamically allocate assets over the life of the fund to reflect investors changing return and liquidity needs as they progress towards a specified “target date,” generally retirement.
Q. So Target Date Funds have been seeing huge inflows over the past year… what are they, and what’s driving their popularity?
A. The basic idea is dynamic portfolio allocation over time, with an increasingly conservative mix as someone gets closer to retirement. So the standard TDF holds mostly stocks for young people far from retirement age, and nearly all bonds for older holders. You select them by year of retirement, say a 2040 fund– and the asset mix adjusts over time according to a specified “glide path.”
Q. And why have they been growing so fast? Several sources have them up to $100 billion or so, growing by almost a third over the past year.
A. A big part of the answer is that they’ve become very common inside defined contribution” plans retirement plans. Indeed, plan designs are such that people are being “defaulted” into this sort of option when they sign up.
Q. Now, since this show is about alternatives, I suspect there must be some connection…
A. Yes. The big news is that TDFs are starting to be a bit of a back door into alternatives for average folks. That’s because, instead of just using the standard mutual fund format to provide a TDF inside of a plan, many plan sponsors are creating custom TDFs in formats that can hold less liquid assets. For example, collective trust funds, and separately managed accounts, can hold, say, real estate, in a way that mutual funds can’t.
Q. So that’s sort of interesting from a fiduciary duty point of view– these plan sponsors are making the decision that diversifying out of traditional stocks and bonds is in the best interest of plan participants. Is that a heavy lift for them?
A. Yes, it really is a very interesting development. A lot of the concern is around the interest rate risk in bonds right now: they’ve only been at this kind of rate for about 3% of the entire time government bonds have existed, and if they move back to historic norms their value could get crushed. But, more generally the idea is: if you’re going to diversify for safety, really diversify for safety. And I think you’ll see a lot more of that sort of thinking going forward.