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Examining Effectiveness of Target Date Funds

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Easy Does It or Easy Doesn’t Do It?

It’s fair to say that most peo­ple like when com­pli­cat­ed con­cepts or dif­fi­cult tasks are ‘made easy’.

It’s also fair to say that the two biggest inno­va­tions in man­aged finan­cial prod­ucts over the last two decades are exchange trad­ed prod­ucts (ETPs) and tar­get date funds. Lit­tle sur­prise there.

But how have some of these ‘made easy’ prod­ucts deliv­ered upon their expec­ta­tions over time?

Accord­ing to Morningstar’s “2015 Tar­get-Date Land­scape” report, there is an esti­mat­ed $700bn of assets under man­age­ment in tar­get date funds, up from $100bn a decade before. In addi­tion, there is an esti­mat­ed $300bn in col­lec­tive invest­ment trusts (CITs) that are invest­ed along the same lines as tar­get date funds. This adds up to $1 tril­lion of assets and some experts expect that num­ber to dou­ble to $2trn with­in the next sev­er­al years. (Source: “Tar­get Date Funds Take Over,” Barron’s, July 5, 2014, Andrew Bary)

Net Asset Flow into Target Date Funds - Morningstar | Swan Blog

Retirement Investing ‘Made Easy’ — Target Date Funds

Cer­tain­ly hav­ing a “one-click solu­tion” for defined con­tri­bu­tion plan par­tic­i­pants offers a lot of advan­tages. Accord­ing to a May 2015 report from the Gov­ern­ment Account­abil­i­ty Office, 52% of house­holds over the age of 55 have no 401(k) or IRA sav­ings, and of the 48% who do the medi­an val­ue is only $109,000. Giv­en the wide­spread finan­cial illit­er­a­cy and low sav­ings rates of the aver­age Amer­i­can, mak­ing the process of sav­ing for retire­ment as easy and pain­less as pos­si­ble is an attrac­tive propo­si­tion. (Source: “Retire­ment Secu­ri­ty: Most House­holds Approach­ing Retire­ment Have Low Sav­ings”)

The con­cern, how­ev­er, is that by uti­liz­ing a “pain­less” solu­tion at the out­set, investors are set­ting them­selves up for pain in the future.

  • Can tar­get date funds deliv­er enough growth to fund an aver­age investor’s retire­ment?
  • How well have tar­get date funds pro­tect­ed cap­i­tal?

Made Easy’ Products May Make Retirement ‘Not So Easy’

Unfor­tu­nate­ly, the track record of the aver­age tar­get date fund has been under­whelm­ing. The graph below shows the risks and returns across sev­er­al “vin­tages” of Morn­ingstar cat­e­go­ry aver­age tar­get date funds, ver­sus the DRS.

Risk - Return Profile of Target Date Funds vs DRS | Swan Blog

Source: Zephyr StyleAD­VI­SOR, Swan Glob­al Invest­ments

Cer­tain­ly, the risk has increased across the spec­trum as one moves from con­ser­v­a­tive to aggres­sive. But what has been lack­ing is a cor­re­spond­ing increase in returns. It is unlike­ly that returns in the 5% range were what investors in these prod­ucts were antic­i­pat­ing. How­ev­er, what is per­haps more con­cern­ing is how tar­get date funds per­formed dur­ing the big equi­ty bear mar­kets.
Max Drawdown- SP 500 Index, Target Date Funds, and DRS | Swan Blog

The above chart details the peak-to-trough loss­es of the aver­age tar­get date funds over the last 18 years, ver­sus the DRS.

Of par­tic­u­lar con­cern is the per­for­mance of the aver­age Morn­ingstar Tar­get Date 2000–2010 fund dur­ing the 2007-08 cor­rec­tion. These port­fo­lios were some of the most con­ser­v­a­tive tar­get date funds avail­able, posi­tioned as appro­pri­ate for some­one who was plan­ning on retir­ing some­time between the year 2000 and 2010. And yet when the cred­it cri­sis hit in 2007-08 these funds lost an aver­age of 31.03%. They spent a full three years under­wa­ter before recov­er­ing their loss­es. Many Amer­i­cans were hit dou­bly hard dur­ing this peri­od, where their invest­ment loss­es were paired with unem­ploy­ment, stag­nant wages, falling home val­ues, or oth­er finan­cial chal­lenges.

Another Way to ‘Make It’ on Target

The poor per­for­mance of the tar­get date funds, espe­cial­ly dur­ing the two major bear mar­kets since 2000, high­lights one of the core tenets of Swan Glob­al Invest­ments’ phi­los­o­phy.

We believe that tra­di­tion­al asset allo­ca­tion and diver­si­fi­ca­tion fails to suf­fi­cient­ly pro­tect wealth dur­ing peri­ods of severe mar­ket down­turns.

After all, the text­book descrip­tions of asset allo­ca­tion often state that mar­ket risk, or sys­tem­at­ic risk, sim­ply can­not be diver­si­fied away. The vast major­i­ty of tar­get date funds seem to pas­sive­ly accept this risk by hold­ing the vast major­i­ty of their assets in sim­ple stock-bond com­bi­na­tion.

Asset Allocations in Target Date Funds -Morningstar |Swan Blog

The Defined Risk Strat­e­gy dif­fers from this pas­sive approach. The DRS takes an active role in con­fronting mar­ket risk and does so via clever hedg­ing strate­gies. Our dis­tinct invest­ment approach has been applied to a range of asset class­es in a suite of DRS mutu­al funds. Orig­i­nal­ly applied to U.S. large cap stocks in 1997, the DRS is now avail­able on U.S. small cap stocks, for­eign devel­oped mar­ket equi­ties, and emerg­ing mar­ket stocks.

More­over, Swan Glob­al Invest­ments in con­junc­tion with Gor­don Asset Man­age­ment has recent­ly unveiled a fam­i­ly of col­lec­tive invest­ment trusts (CITs) uti­liz­ing the DRS. Giv­en tar­get date funds’ poor per­for­mance based upon tra­di­tion­al asset allo­ca­tion described pre­vi­ous­ly, we believe the DRS address­es the biggest short­com­ing in an oth­er­wise prac­ti­cal idea.

The myr­i­ad of prob­lems fac­ing baby boomers as they enter retire­ment are explored fur­ther in the Swan white paper, “The Retire­ment Conun­drum: Unty­ing the Gor­dian Knot.

Feel free to review more infor­ma­tion on the Defined Risk Strat­e­gy per­for­mance, or its com­po­nents, call 970.382.8901.


Marc Odo, Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Director of Investment Solutions - Swan Global InvestmentsAbout the author: Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Direc­tor of Invest­ment Solu­tions, is respon­si­ble for help­ing clients and prospects gain a detailed under­stand­ing of Swan’s Defined Risk Strat­e­gy, includ­ing how it fits into an over­all invest­ment strat­e­gy. For­mer­ly Marc was the Direc­tor of Research for 11 years at Zephyr Asso­ciates.



Impor­tant Notes and Dis­clo­sures:

Swan Glob­al Invest­ments, LLC is a SEC reg­is­tered Invest­ment Advi­sor that spe­cial­izes in man­ag­ing mon­ey using the pro­pri­etary Defined Risk Strat­e­gy (“DRS”). SEC reg­is­tra­tion does not denote any spe­cial train­ing or qual­i­fi­ca­tion con­ferred by the SEC. Swan offers and man­ages the DRS for investors includ­ing indi­vid­u­als, insti­tu­tions and oth­er invest­ment advi­sor firms. Any his­tor­i­cal num­bers, awards and recog­ni­tions pre­sent­ed are based on the per­for­mance of a (GIPS®) com­pos­ite, Swan’s DRS Select Com­pos­ite, which includes non-qual­i­fied dis­cre­tionary accounts invest­ed in since incep­tion, July 1997, and are net of fees and expens­es. Swan claims com­pli­ance with the Glob­al Invest­ment Per­for­mance Stan­dards (GIPS®). All data used here­in; includ­ing the sta­tis­ti­cal infor­ma­tion, ver­i­fi­ca­tion and per­for­mance reports are avail­able upon request. The S&P 500 Index is a mar­ket cap weight­ed index of 500 wide­ly held stocks often used as a proxy for the over­all U.S. equi­ty mar­ket. Index­es are unman­aged and have no fees or expens­es. An invest­ment can­not be made direct­ly in an index. Swan’s invest­ments may con­sist of secu­ri­ties which vary sig­nif­i­cant­ly from those in the bench­mark index­es list­ed above and per­for­mance cal­cu­la­tion meth­ods may not be entire­ly com­pa­ra­ble. Accord­ing­ly, com­par­ing results shown to those of such index­es may be of lim­it­ed use. The adviser’s depen­dence on its DRS process and judg­ments about the attrac­tive­ness, val­ue and poten­tial appre­ci­a­tion of par­tic­u­lar ETFs and options in which the advis­er invests or writes may prove to be incor­rect and may not pro­duce the desired results. There is no guar­an­tee any invest­ment or the DRS will meet its objec­tives. All invest­ments involve the risk of poten­tial invest­ment loss­es as well as the poten­tial for invest­ment gains. Pri­or per­for­mance is not a guar­an­tee of future results and there can be no assur­ance, and investors should not assume, that future per­for­mance will be com­pa­ra­ble to past per­for­mance. All invest­ment strate­gies have the poten­tial for prof­it or loss. Fur­ther infor­ma­tion is avail­able upon request by con­tact­ing the com­pa­ny direct­ly at 970–382-8901 orwww.swanglobalinvestments.com016-SGI-012016[/fusion_builder_column][/fusion_builder_row][/fusion_builder_container]

By |2018-10-09T16:58:51+00:00January 26th, 2016|Blog|Comments Off on Examining Effectiveness of Target Date Funds