PensionsNov 25 2013

Target date funds: A moving target

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      CPD
      Approx.30min
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      CPD
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      Saving for retirement is a long-term game. It involves looking many years into the future and deciding how to invest without knowing what’s coming.

      Auto-enrolment has brought a whole new wave of individuals into pensions. In the absence of individual advice for every member, advisers and employers are looking for suitable default strategies for their workforce. Lifestyle strategies have historically been the default, but the perceived wisdom of almost automatically switching from equities to bonds is increasingly facing criticism. Target date funds are one possible solution to this problem but, as a relatively new product in the UK, can they meet the retirement needs of coming generations?

      What are they?

      Target date funds will differ by manager, like any type of pension fund. However, there are some key traits common to the structure.

      They are managed based on a set time horizon, specifically the expected retirement date. Some providers have a fund for each year, while others offer funds at intervals of several years to lower the number of funds and thus costs. In the former, a 2025 retirement date fund would be used for those planning to retire in that year; in the latter, the 2025 fund might be used for those planning to retire within five years of 2025.

      Capital appreciation is the main aim at the beginning of the savings period, which means investing in riskier assets, usually equities. Chart 1 shows an estimate of the average asset allocation across default defined-contribution pension schemes using a target date or lifestyle strategy.

      As the retirement date nears, a move towards capital preservation is made, creating a ‘glidepath’ towards retirement. Throughout the lifespan of the fund, a multi-asset, multi-manager approach is typically used, with some providers staying in-house for their fund selection — a ‘closed architecture’ approach — and others accessing the whole market through ‘open architecture’. Both active and passive strategies may be selected.

      Strategic asset allocation will take into account the risk based on time from the specified retirement date. Dynamic asset allocation may also be used, where short-term strategies are used to supplement the long-term view, either taking advantage of prevailing market conditions or protecting against them.

      Growing interest

      According to Henry Cobbe, managing director of BirthStar funds, target date funds have existed in the US for 20 years. They took off in 2006 when auto-enrolment was implemented there and they were one of the eligible fund types for such schemes. Mr Cobbe says assets in target date funds in the US have grown from $50bn in 2005 to $540bn today.

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