(November 21, 2013) — Target-date funds are fundamentally flawed and are failing defined contribution retirees, according to a paper by Research Affiliates, who have created a new model for the industry to try out.
The objectives of a traditional “glidepath” approach, namely maximising the real value of nest eggs and minimising uncertainty around prospective retirement income, are actually not met, the authors said and tested a range of alternatives.
“First, rebalancing to a static mix beats a gradual shift to bonds (or equities for that matter, because the solutions are not linked to expected market environments),” the paper began. “Second, adjusting the risk profile within stock and bond portfolios rather than across asset classes reins in risk more constructively than the classic glidepath solutions. Third, incorporating valuation-indifferent equity strategies improves the historical performance of the solutions relative to alternatives built using cap-weighted indexes.”
The paper showed the authors’ working on these points and offered an argument for more time to be spent on constructing funds. It argued that the basic idea of younger workers buying equities for their pension portfolio then moving into bonds as retirement approaches had been proved to be a flawed idea, yet many in the industry have bought—and continue to buy into—the idea.
“Our alternatives are deliberately simple, so that they illustrate our points vis-à-vis existing target-date alternatives; we acknowledge (and believe) that skilled active managers can achieve superior results, particularly when they customise these solutions for an individual investor.”
The authors called on the asset management industry to do more to create strategies that help the end investor attain their retirement income goals and to think outside the box. Clients need help in realising what level of income would be attainable and framing their objectives, the authors added.
Finally, the industry must realise that it needs to question current approaches when empirical evidence is produced to disprove their efficacy.
“Our illustrative strategies are no recipe for replacing the classic glidepath strategies; they merely illustrate how easy it is to improve our clients’ prospective retirement income and wealth.”
The authors said a more sophisticated solution might add a whole spectrum of additional asset classes—outside the traditional equities and bonds—that could offer higher yields, growth, or both, than the current glidepath portfolio.
The authors concluded: “These represent avenues for future research, which we invite others to join us in pursuing.”
To read the full paper, click here.
Related content: Testing the Target-Date Theory, Ben Bernanke vs Target Date Funds & Is Lifestyling Dead?