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How the structure of target date funds helps performance

This article is part of
Guide to using Target Date Funds

How the structure of target date funds helps performance

Target Date Funds (TDFs) have several advantages over lifestyling when it comes to performance.

Unfortunately, data is not actually available for performance of lifestyling, but data has been made available for TDFs.

Nest, the government-backed scheme for auto-enrolment savings, reports the annualised performance of the higher risk fund, with a target date of 2040, has produced an annualised return over three years of 10.8 per cent and since launch of 9.7 per cent, net of management charges.

This fund has holdings in tech stocks such as Apple, Amazon and Facebook, as well as financials including JP Morgan Chase and Bank of America.

The Nest Ethical fund shows an annualised return of 12.9 per cent over three years, and has holdings such as Praxair, Roper Technologies and Paypal Holdings. The Sharia fund has done even better, returning 16.7 per cent on an annualised basis over three years.

The growth phase TDF, with a target date of 2040, has an allocation of 7.3 per cent in global emerging market equities, and 34 per cent in global developed equities.

Positive performance

Paul Todd, director of investment development and delivery at Nest, says: "The actual asset allocation is done by the Nest in-house investment team. We're taking all the decisions in terms of each fund and in terms of what the asset allocation is.

"We have an in-house investment team of 18 or 19 people. Most of them come from the investment industry. The actual delivery and execution of the investment is done through our external fund managers."

He goes on: "Performance has been really, really positive and has significantly outperformed our investment objectives, which is to beat inflation plus 3 per cent after all charges.

"The performance is not because we have a TDF but it's because we've invested wisely within TDFs. The TDF is a good vehicle for delivering that return - some of the outperformance is down to the fact that we've used the TDF structure, but the majority is we've invested in it on a sensible basis.

"Not only are we achieving outperformance in terms of return, we've achieved that in terms of taking a lot less risk."

Figure 1: UK retail target date funds - cumulative performance

Source: Elston Consulting research, Bloomberg data. From 31 December 2015 to 29 June 2018 (daily data) based on retail accumulation units

Henry Cobbe, director of Elston Consulting, says that much of it is driven by getting the asset allocation right. 

He says: "When the target date is further into the future, the investment mix has a higher risk return profile, and when the target date is closer in the future, the investment mix is a lower risk return profile.

"When the target date is in the past, the investment mix, has a lower risk return profile. Their risk return profile is consistent across the investment industry but it's wrapped up in a single fund. The changing asset allocation mix over time is the glidepath."