How the structure of target date funds helps 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."

Managed as a collective

In many ways TDFs operate in the same way as a multi-asset fund, and all the switching is done in the fund. Compared to lifestyling this cuts down on many transactional costs.

Mr Cobbe says: "If they're all in the same group, they're being managed as a collective and that reduces dealing costs and improves consistency."

Economies of scale kick in, and by having everyone in the same cohort, develops consistency for that group of people.

Mr Cobbe confirms: "It's about the investment journey rather than measuring points in time. It comes down to risk management. If you're a Sipp provider and trying to think about customer outcomes, thinking about scheme members in terms of cohorts enables you to share the balance of risk and return as appropriate."

Elston Consulting has put together performance data on two retail propositions - from Vanguard and Architas.

It shows that cumulative returns for Architas 2050 funds are looking at just over 40 per cent, while Vanguard is just over 35 per cent; the 2020 cohort for Architas is around 22 per cent and 27 per cent for Vanguard.

Annualised returns increase as each cohort gets further from imminent retirement dates. Annualised returns for Vanguard 2020 cohort are 10 per cent, the 2030 cohort is 12 per cent and the 2040 cohort is just over 13 per cent.

The Architas TDFs perform slightly better with the 2040 cohort looking to return just over 14 per cent, although the 2020 group is looking at an annualised return of about 8.5 per cent.

Annualised 260-day volatility is about 6 per cent for Vanguard, and just over 4 per cent for Architas in the 2020 fund; for the 2045 fund it is just over 8 per cent volatility for Vanguard and about 9 per cent for Architas.

Clearly, Target Date Funds have a lot to offer, and have been shown to be popular in the US.

It is a question of consumers becoming more aware of them and knowing where to look for these funds, and trusting the investment industry to deliver.

melanie.tringham@ft.com