Target Date Funds Research Articles

Practical Applications of Using Participant Data to Improve Target-Date Fund Allocations

Practical Applications of Using Participant Data to Improve Target-Date Fund Allocations

Practical Applications of Personalized Target-Date Funds

Practical Applications of Personalized Target-Date Funds

Practical Applications of Target-Date Funds—Mis-Sold and Misused

Practical Applications of Target-Date Funds—Mis-Sold and Misused

Performance dispersion among target date funds

There are significant differences in the performance of Target Date Funds (TDFs) with the same target year. Using a unique dataset from Morningstar, we show that within the same target year, funds with lower than the average expense ratio, or higher than average allocation to equities, outperform similar funds. This outperformance exists across all target year groups and is economically meaningful. Furthermore, deviations in the equity allocation have a greater impact on performance than does expense ratio. Using bootstrap simulations to investigate the impact over a longer horizon, we show that deviations from the average allocations or expense ratios have a meaningful impact on the retirement savings of an average investor.

Personalized Target-Date Funds

Personalized Target-Date Funds

Managing the shortfall risk of target date funds by overfunding

Abstract Is it possible to achieve almost riskless, nonfluctuating investment payoffs in the long run, at a fraction of the traditional funding requirement, using equity investments? What is their shortfall risk? These questions are motivated by the need to increase yields, while limiting the variability of investment results. We show how to use contingent claims, denominated in units of a stock index, to achieve an almost riskless investment outcome. To control the risk of the proposed hedge portfolios, we introduce an overfunded scheme and show its reliability using bootstrapping. Results show that a modest amount of overfunding is an effective risk-management approach that brings the probability of not achieving the target to less than 1 percent. Our results are based on the use of the minimal market model and a change of numeraire. Robustness tests support their validity under different market specifications.

Target Date Funds and International Capital Flows

Target Date Funds and International Capital Flows

Missing the Target? Retirement Expectations and Target Date Funds

Missing the Target? Retirement Expectations and Target Date Funds

Back to the funding ratio! Addressing the duration puzzle and retirement income risk of defined contribution pension plans

Effective risk management in pension funds requires the use of appropriate long-term risk and performance indicators. However, Defined Contribution (DC) pension plans currently rely on short-term metrics that don't align with the retirement income goals of beneficiaries. Against this backdrop, we introduce a funding ratio measure for DC plans defined as the plan assets divided by accrued benefits derived from any given (defined) stream of contributions. The funding ratio's denominator is the present value of the total retirement income achievable if all contributions had been invested in fully amortizing fixed-income portfolios called retirement bonds. We also use the retirement bonds to introduce a class of target-income strategies that can effectively reduce income risk as retirement approaches, but also secure minimum funding ratio levels. These simple asset allocation rules strongly dominate the standard target-date fund strategies routinely used by DC plans, in terms of retirement outcomes for beneficiaries.

Using Participant Data to Improve Target Date Fund Allocations

Using Participant Data to Improve Target Date Fund Allocations

Target date funds as asset market stabilizers: evidence from the pandemic

Abstract Target date funds (TDFs) provide retirement investors, many of whom are unsophisticated or inattentive, with age-appropriate exposures to different asset classes like stocks and bonds. To maintain exposures, TDFs trade actively against market returns, buying stock funds when the stock market does poorly, and selling when the market does well (Parker et al., 2023, Journal of Finance). This paper shows that trading by TDFs was a significant stabilizing force in US equity markets during the unprecedented economic volatility of the COVID-19 pandemic period. Specifically, TDFs – now comprising a quarter of all 401(k) plan assets – caused significant contrarian investment flows across asset classes, flows that were not undone by enrollment of TDF investors or by discretionary actions by TDF managers. Mutual funds with large ownership by TDFs had more stable funding through the pandemic, and stocks that had greater indirect ownership by TDFs had lower co-movement with the market and lower volatility during the pandemic period.

Target Date Fund Flows Amidst the COVID-19 Pandemic

The popularity of target date funds (TDFs) has recently increased among defined contribution pension plans. Despite their growing importance, how TDF flows and flow-performance relationships have changed in response to the COVID-19 pandemic is yet to be examined, particularly during the March 2020 market turmoil, when bond funds witnessed unprecedented outflows. We find that short-horizon TDFs experienced sizable outflows of over $13.5 billion between February and April 2020, whereas mid- and long-horizon TDFs received inflows over the same period. Given that short-horizon TDFs hold a much larger fraction of their portfolios on fixed-income securities, the outflows from these TDFs, whose fund-of-funds investment structure has been identified as a source of intra-family liquidity provision in previous studies, may have compromised the effectiveness of this liquidity provision mechanism during the COVID-19 market crash. We find that in the aftermath of the pandemic, the flow–performance relationship of short-horizon TDFs becomes markedly more concave, which hints at investors’ greater awareness of the downside risks associated with large outflows following their experience during the COVID-19 turmoil.

Target Date Funds—Mis-Sold and Misused

Target Date Funds—Mis-Sold and Misused

Saving for retirement in Europe: the long-term risk-return tradeoff

AbstractA comparison of the performances of pension products that ignores long-term trends might significantly overestimate the long-term impact of volatility risks while underestimating the impact of persistent, low-frequency trends. This paper proposes a comparison making use of projection models based on the long-term risk–return tradeoff proposed by Campbell and Viceira (2005) to explicitly take into account slow-moving economic trends. In order to illustrate the approach and its implications, we discuss the capital protection provided by life-cycle target-date fund strategies and minimum guarantee strategies.

ESG portfolio for TDFs with time‐varying higher moments and cardinality constraint

AbstractPension funds are crucial in supporting environmentally sustainable and socially responsible investments. This paper focuses on an essential product of pension funds, target date funds (TDFs), constructing its portfolio model that considers environmental, social, and governance (ESG) investment. Our model utilizes the mean–variance–skewness–kurtosis optimization framework and accounts for the time‐varying relationship between realized higher moments and subsequent TDFs performance. A cardinality constraint is included to prevent over‐diversification and reduce costs, controlling the number of constituent funds in the TDFs. Since the model is multiobjective, we transform it into a single‐objective optimization through the investment manager's preferences. The numerical experiments represent the most suitable time‐varying higher moment strategy for the Chinese market and demonstrate the model's applicability to managers prioritizing risk over returns, which resonates well with the conservative investment of pension funds. We prove that controlling the number of constituent funds with cardinality constraint is advantageous for improving TDFs' performance. By selecting ESG funds as underlying assets, we highlight that green TDFs have better long‐term performance in terms of higher moment risk.

Portfolio management for insurers and pension funds and COVID-19: targeting volatility for equity, balanced, and target-date funds with leverage constraints

AbstractInsurers and pension funds face the challenges of historically low-interest rates and high volatility in equity markets, that have been accentuated due to the COVID-19 pandemic. Recent advances in equity portfolio management with a target volatility have been shown to deliver improved on average risk-adjusted return, after transaction costs. This paper studies these targeted volatility portfolios in applications to equity, balanced, and target-date funds with varying constraints on leverage. Conservative leverage constraints are particularly relevant to pension funds and insurance companies, with more aggressive leverage levels appropriate for alternative investments. We show substantial improvements in fund performance for differing leverage levels, and of most interest to insurers and pension funds, we show that the highest Sharpe ratios and smallest drawdowns are in targeted volatility-balanced portfolios with equity and bond allocations. Furthermore, we demonstrate the outperformance of targeted volatility portfolios during major stock market crashes, including the crash from the COVID-19 pandemic.

Retail Financial Innovation and Stock Market Dynamics: The Case of Target Date Funds

ABSTRACTTarget date funds (TDFs) are designed to provide unsophisticated or inattentive investors with age‐appropriate exposures to different asset classes like stocks and bonds. The rise of TDFs has moved a significant share of retirement investors into macrocontrarian strategies that sell stocks after relatively good stock market performance. This rebalancing drives contrarian flows across equity mutual funds held by TDFs, stabilizing their funding, and reduces stock returns for stocks disproportionately held by these funds when stock market returns are relatively high. Continued growth in TDFs and similar investment products may dampen stock market volatility and increase the transmission of shocks across asset classes.

Lifestyle, Longevity, and Legacy Risks with Annuities in Retirement Portfolio Decumulation

Investors planning for retirement balance three Ls: (1) lifestyle risk, hoping to maintain a consumption stream that provides a chosen standard of living; (2) longevity risk, hoping to remain solvent throughout their lifetime; and (3) legacy risk, hoping to leave a bequest to their heirs. We solve this multiple objective problem for a wide range of consumption and annuitization scenarios. For each scenario, we apply dynamic programming to optimally evolve the investments in the non-annuitized portion of the portfolio so as to minimize longevity risk. Our dynamic programming approach has the advantages of (1) generating results that are far superior to what standard Monte Carlo methods, static portfolios, and target date fund glide paths can provide and (2) not requiring utility functions, which are hard to specify for individuals. We show that investors who want to minimize their longevity and legacy risk and who are unable to annuitize their full consumption stream are best off avoiding even partial annuitization of their portfolio. For investors who are able to annuitize their full consumption stream, we quantify their longevity versus legacy risk trade-offs, enabling them to select the best annuity for their needs.

Performance’ Improvement on Target Date Fund using GARCH Volatility Forecasting Model

Performance’ Improvement on Target Date Fund using GARCH Volatility Forecasting Model

Target-date funds: lessons learned

Target-date funds are mutual funds with a date in their description. The date signifies the retirement date for the person for whom the mutual fund is designed. The basic proposition is that the fund’s composition will be adjusted as it evolves toward that date, which will relieve the investor of the problem of asset allocation. These funds received a significant boost in 2006 when they became the default choice of many defined contribution plans. However, in our 2011 paper in The Journal of Risk we showed that many funds significantly increased their allocation toward equities immediately prior to the 2007–9 global financial crisis and consequently saw significant losses. Since this was only shortly after target-date funds became a significant component of the mutual fund market, this research assesses the maturation of target-date funds and their performance during the Covid-19 pandemic, when there were again significant market losses. Overall, our assessment is that target-date funds have largely met their designation and there is no evidence of them similarly gaming their asset allocation as occurred prior to the financial crisis.