Some who follow target date fund (TDF) performance have taken note that lately, the S&P Target Date Index Series has outperformed many TDFs. In most historical periods, index performance was middle of the pack. However, 2015 was an exception, as shown in Report 2 of our Year-End 2015 Target Date Scorecard. Every vintage of the S&P Target Date Index Series produced total returns that were close to, or better than, those of funds in the 90th percentile of the target date mutual fund universe.
This story may seem like another chapter in the “index versus active” narrative, but it is particularly puzzling because of the methodology used to determine the benchmark asset allocation and glide path. Every year, S&P DJI determines the asset allocation of each target date index vintage by compiling the holdings and asset-class exposure of a universe of active TDFs and using that data to create benchmark allocations reflecting average exposures of the active universe. The benchmark therefore represents a consensus of asset-class exposure across its glide path; the average opinion, if you will, across the TDF industry. I draw two conclusions from recent performance.
First, there is collective wisdom in the consensus. There are a number of moving parts in every TDF suite. Which asset classes are included? What considerations inform the investment policy? What assumptions are made? How is the glide path expected to shift over time? Which underlying funds are used to implement the investment policy? What is the fee structure? Whereas any individual TDF management team acts in response to an array of investment policy considerations, client interests, and self-interest, the consensus represents the wisdom of the crowd. Collective thinking sometimes has superior value.
Second, it’s hard to beat a portfolio of index funds. Single-asset-class managers and investors are challenged enough when it comes to beating cap-weighted benchmarks like the S&P 500®. The risk of active underperformance is increased when multiple funds are included in a portfolio. Rick Ferri and Alex Benke demonstrate this effect in their paper, “A Case for Index Fund Portfolios.”
One final point about average performance: even if we never see another year like 2015, consistently achieving average performance is a more reliable way of compounding returns over time than alternately bouncing between outperformance and underperformance. Perhaps tracking a market consensus glide path would be more enlightened than most industry insiders care to admit.