Target Date Funds, Drawdown Risk, and Central Bank Intervention: Evidence during the COVID-19 Pandemic

Abstract

Target Date Funds (TDFs) have become the default investment choice in retirement accounts for most households. Later-dated TDFs (e.g., further away from the present day) allocate a more significant percentage of each dollar invested into equities relative to fixed income. As the TDF moves closer to the designated retirement date, the TDF embarks on its’ glide path. We study the impact of the COVID-19 Pandemic and Federal Reserve intervention on the max drawdowns experienced by TDFs during 2020. Later-dated funds experienced more significant drawdowns relative to near-dated funds. Moving out one target date fund increased the drawdown by approximately 1.90%. Approximately 80% of TDFs experienced their max drawdown on 23 March 2020. The max drawdowns of the TDFs are then studied in the following three sub-periods: (1) before the first Federal Reserve Intervention (2 March 2020), (2) after the first intervention and before the second intervention (16 March 2020), and (3) the period after the second intervention. TDFs experienced the greatest drawdowns after the first intervention by the Federal Reserve (approximately 19%) relative to the other two periods (approximately 7%). Fees associated with the TDFs tend not to influence the drawdowns except for the near-dated funds, where the low-fee funds performed better. Finally, near-dated funds recovered from their max drawdowns around September 2020, whereas later-dated funds did not fully recover until December 2020.