Glide Path and Dynamic Asset Allocation of Target Date Funds

Abstract

The glide path of typical target date funds is based on the relatively simple assumption of risk. If an explicit term structure of risk is present or risk is time-varying, the conventional glide path may not be adequate to fulfil the purpose of target date funds. We introduce a new approach to define the glide path of target date funds. Our starting point is to determine the level of risk budget for each target date. According to the pre-defined risk budget, we derive the asset allocation of target date funds by explicitly incorporating the current term structure of risk. Because risk does change through different market phases, we implement a dynamic asset allocation strategy for target date funds which considers simultaneously both the pre-defined risk budget and the prevailing market risks. The main difference is that at any given time our risk-controlled dynamically-rebalanced target date funds would not exceed the pre-defined risk budget regardless of market movements.