(March 11, 2013) – Most target date funds are taking on the same level of risk as open defined benefit pension funds for members just a decade from retirement, a study has found, despite the vast different in investor time horizons.
In a whitepaper titled “Target Date Funds: Still Off Target?,” consultant Mark Fandetti argues that target-date (TD) fund managers have not adequately applied the lessons they ought to have learned in 2008: de-risk in the final stages of a member’s working life. Fandetti the head of defined contribution for Boston-based investment consultancy Meketa Investment Group, and based his study on Morningstar data covering the performance of 111 target-date funds. He was not overly impressed with what he found.
“Unfortunately, shorter-dated TD funds may remain too aggressively invested, despite the ‘lessons’ of 2008,” he wrote. “Most short-term TD funds take pension fund-like risk, but whereas pension fund investment horizons are usually very long-term, TD fund investor horizons are not. It is therefore almost inconceivable that participants that would choose a shorter-dated TD fund can tolerate the same level of interim losses as a pension fund.”
Fandetti found that in 2008, 73% of funds with target dates between 2011 and 2015 lost more than 25% of their value. Funds with target dates between 2016 and 2025 average a loss of 30% that year-a hit he felt was substantial enough to leave many retirement plans “permanently derailed.”
To avoid these dramatic drawdowns, the author advised plan sponsors to review their line-up of target-date funds, and ask if the current portfolios are more aggressive than, for example, the company’s defined benefit plan (if it has one). If so, Fandetti urged sponsors to question the appropriateness of that level of risk given members’ proximity to retirement.
“The lack of more conservative shorter-dated TD fund choices means that plan sponsors seeking a less aggressive manager for participants at or near retirement may be better served with a custom-TD fund manager, as opposed to settling for an ‘off the shelf’ TD fund managed by a mutual fund company,” he concluded. “Such an approach preserves the virtues of TD funds, such as professional investment management and periodic rebalancing, while avoiding the high risk assumed by some (but not all) TD fund managers.”
Related magazine feature: “The Target Date Conundrum: How Much Custom Is Enough?“