Target date funds have seen tremendous growth. At the end of 2019, assets in target date mutual funds reached nearly USD 1.4 trillion, impressive growth from USD 256 billion a decade ago. Other than a brief dip in the fourth quarter of 2018, the growth of assets has been fairly stable with an upward trajectory (see Exhibit 1).
Several variables drive this sustained growth. Target date funds are used by many plan sponsors as one of the qualified defined investment alternatives (QDIA) under Department of Labor regulations. At the same time, the burden of saving adequately for retirement now falls squarely on employees as plans shift from defined benefit structures to defined contribution structures. That means that relatively unsophisticated plan participants need to make investment decisions on asset allocation and portfolio construction. Against that backdrop, it’s not surprising to see target date funds gaining traction among defined contribution plans, as they offer a one-stop shop solution. They are often the default investment option on employer retirement plans.
There is fair degree of heterogeneity in target date funds’ construction, leading to substantial dispersion in realized returns even within the same category. Returns differ for several reasons:
- Different glide path construction, which determines how asset allocation shifts over time;
- Capital markets assumptions; and
- Asset classes used.
For example, the spread between the 90th percentile fund and the 10th percentile fund for the 2020 target date vintage is nearly 507 bps. The spread varies with the year, but the average across all vintages amounts to approximately 430 bps (see Exhibit 2).
In an extreme scenario, consider two plan participants entering the workforce at two different firms at the beginning of 2020, with each having an identical 40-year time horizon. Each participant enrolls in a 2060 target date fund offered by their respective firm. Additionally, if we further assume that one fund is in the top decile while the other is in the bottom, then the difference in compounded returns between the top- and bottom-decile funds over a 40-year working life could be as much as 400% on a cumulative basis. Therefore, performance drag can make a meaningful difference in determining whether a participant has adequate savings for retirement.
All of this raises the issue of how to evaluate the performance of a target date fund. Target date funds are sometimes benchmarked to a static portfolio with fixed weights of equity and bonds, such as a 60/40, or in an egregious case, simply to the S&P 500®. Neither one is truly reflective of a fund’s objective or reflective of the outcome investors receive.
Employees nowadays face the difficult burden of saving adequately for their retirement years. Target date funds are innovative solutions providing pre-packaged investment decisions that plan participants would otherwise have to make. Unfortunately, there is no uniformity when it comes to the construction of target date funds, making it difficult to determine whether the funds are truly delivering for their plan participants. Independently calculated and governed target date benchmarks, like those offered by S&P DJI, fill that gap by providing transparency and easy performance attribution.
 Based on quarterly assets data from the Investment Company Institute.
 A QDIA is a default investment option chosen by a plan fiduciary for participants who fail to make an election in their investment accounts.
 We assume that the top-decile and the bottom-decile target dates remain in their respective deciles over the course of the 40-year horizon and maintain the 2060 vintage spread of 3.58%. The difference is then compounded over the 40-year horizon.The posts on this blog are opinions, not advice. Please read our Disclaimers.