When it comes to target date funds, cost matters. But since participants could be invested in these funds for decades, every potential advantage should be considered. For a fully active solution, there are three potential sources of excess return to consider, as actively managed target date funds seek to deliver value in three ways.
The first is through the choice of a strategic glide path, the long-term targeted allocations to various asset classes (primarily equity versus fixed income). The second is through tactical allocations, purposeful shifts from those asset allocations in response to market conditions. The third way — a critical differentiator — is through security selection, the potential to generate excess returns via active management decisions.
But passive target date solutions1 — which constitute the majority of the nearly $3 trillion invested in the industry2 — may not have access to the potential benefits of active security selection. While fees are incredibly important, they should not be the sole determining factor in selecting a target date series. Recent litigation has highlighted the importance of relative returns and overall participant outcomes as well as absolute returns. Simply focusing on fees and costs is no longer enough to avoid litigation risk. And, more importantly, it may not provide the best outcome for participants.
While strategic glide path differences between target date series are narrowing, other factors such as asset class allocations and active investment selection have played a greater role in affecting series outcomes and “plan sponsors and their consultants should focus on these factors” to better understand the disparity in target date outcomes.3
These factors are derived from an examination of the underlying funds, or “ingredients,” of an actively managed target date series, as the managers of these building blocks are responsible for fundamental security selection.
In the paper linked below, we take a closer look at the funds underlying the American Funds Target Date Retirement Series in terms of both return and risk to illustrate how they seek to drive better outcomes for participants.
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1 Target date types as described by Morningstar, uses the percentage of a series’ assets in underlying active strategies to classify each series as active (80% to 100% actively managed), hybrid (20% to 80% actively managed) or passive (less than 20% actively managed). A passively managed target date series may benefit from active security selection based on the percentage of the series that may be actively managed.
2 SWAY research report, “State of the Target-Date Market: 2023,” January 2023.
3 Blanchett, David and Paul D. Kaplan. “Beyond the Glide Path: The Drivers of Target-Date Fund Returns,” The Journal of Retirement, 5(4), 25–39, Spring 2018.
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.
Although the target date portfolios are managed for investors on a projected retirement date time frame, the allocation strategy does not guarantee that investors' retirement goals will be met. Investment professionals manage the portfolio, moving it from a more growth-oriented strategy to a more income-oriented focus as the target date gets closer. The target date is the year that corresponds roughly to the year in which an investor is assumed to retire and begin taking withdrawals. Investment professionals continue to manage each portfolio for approximately 30 years after it reaches its target date.
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