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Target date fund (TDF) companies would have us believe that their 2008 performance failure was a passing hiccup that will go away. The 20%-plus loss in near-dated funds is acceptable because the target date is simply a speed bump in the highway of life.
Don’t believe them. And don’t believe it when they tell us they are managing mortality risk or that TDFs should be designed to last from the cradle to the grave.
The fund companies have yet to identify and acknowledge the real problems in their offerings. The emperor has no clothes.
The 2008 global financial crisis reveals that TDFs are not all that they’re cracked up to be. The typical 2010 TDF lost more than 20% in 2008. Some current retirees are invested in 2010 funds because of the practice of bracketing the target date by five years, so 2010 funds are for those retiring between 2005 and 2015.
The media has expressed disappointment in the 2008 results but has not uncovered the real problems because it has allowed the TDF companies to hide behind their pat speed bump explanation. Truth cannot emerge from interviews with the culprits.
The truth is that the target date industry entered into a performance race in 2006 and 2007, raising equity allocations and justifying the increase based on longer life expectancies, as though we all suddenly decided to live longer. The timing of course was awful, but even more shameful is the cover-up and unwillingness to correct an obvious mistake. TDFs should not be managing mortality risk, as explained in detail below.
Target date funds (TDFs) have been gaining in popularity, in part because the Pension Protection Act of 2006 made them Qualified Default Investment Alternatives (QDIAs) for defined contribution pension plans. TDFs have been the preferred QDIA because they are “set it and forget it,” and they should improve upon decisions that are typically made by participants. Now it’s time for the target date industry to deliver on its hype.
The faulty speed bump rationalization is not the only flaw in TDFs. The designs of every single target date fund family are flawed in ways that can and should be corrected. Every fund family suffers from the following shortcomings:
Problems with Target Date Funds
- Poor risk controls. The average 2010 fund had a 45% equity allocation at the end of 2008. The typical TDF holds 35% in equities at the target date.
- Inbreeding. Most target date families are comprised exclusively of funds managed by the fund company. Even though the active-passive debate rages on, most would agree that closed architecture limits the potential for active rewards.
- Lack of diversification. Most are predominantly US stocks and bonds.
- Haphazard glide paths. Glide paths are generally ad hoc, with arbitrary decreases in equity allocations through time. A better approach is to model a glide path that offers reasonable likelihoods of achieving agreed-upon objectives.
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