Why they are good for the disengaged investor

The most important point is keeping in mind when you want the money - at age 65, or when your child hits 18. 

And for the retail investor, they are an easy, ready-made option for someone who does not want to think about managing their savings, but to leave them locked up and allow the assets to grow, ready for the end point when they need them.

Henry Cobbe, director of Elston Consulting, says: “They’re designed to grow when they’re designed to grow. They’re a ready-made strategy for someone who doesn’t know how to make these choices.

“They nudge you into the right strategy. It’s ideal for the low engaged customer, where other people will do [the fund switches] for you.”

TDFs are available to retail investors on platforms such as Hargreaves Lansdown, and for the retail investor, with providers Vanguard and Architas offering TDFs direct.

Investors who want to take this option can simply self select, using a number of different approaches.

While a TDF is cautiously managed after the target date, it’s up to the investor to manage their own withdrawal rate.Henry Cobbe

Mr Cobbe notes: “The first strategy is a 'One and done' fund: what year do you turn 65? That’s your target date. Pick the matching TDF and let it do the rest for you so you can get on with your life. 

“The second option is goal-based funds: the target date is the date you expect withdrawals to commence. So if you are saving up for a goal, for example, saving for children’s university fees in a JISA [Junior Isa], this is an easy, risk-managed way of doing it. 

“You get the growth in the earlier years but the strategy gets more cautious as you get closer to the time you need the money. There is no lock-in, so if you want to switch or change your target date it’s just like any other fund.

“The third option is decumulation: the target date is the date you expect withdrawals to commence. That date may be in the past if you are in decumulation."

He adds: “While a TDF is cautiously managed after the target date, it’s up to the investor to manage their own withdrawal rate."

Default strategy

On the institutional side, target date funds are used for workplace schemes, and have been taken up by master trusts.

Nest, for example, uses them as its default fund, after deciding it was the best option for people who did not want to be actively engaged in the management of its pension fund.

Paul Todd, director of investment development and delivery at Nest, says: “We’ve been using TDFs since we first started investing back in 2011. Our expectation was the vast majority of the membership wouldn’t be taking an active decision when they auto-enrolled, and 99 per cent are in the default strategy.”

The default strategy runs 47 individual TDFs, one for each retirement year.

Mr Todd says: “We can give people an individual glidepath from the age of 22 to 67 - we can have a bespoke glidepath to reflect the different release dates from when they start investing to when they get close to retirement.

“It provides an enormous amount of flexibility to change how people are invested over their life plan, in the way that traditional lifestyling doesn’t do.”

Some things are unpredictable, such as the regulatory landscape.

Mr Todd says: “When pension freedom and choice happened it allowed us to change our glidepath to reflect this new reality. It gives you a lot more flexibility in terms of how you allocate in terms of different asset classes and how that invariably changes over time.”

Fund hopping

In addition, instead of triggering dealing costs when moving in and out of different assets, to accommodate different asset classes, as funds head towards the retirement date the riskier assets are simply allocated to the funds with a later retirement date, where it is now more appropriate.

Creative Wealth Management, which is a specialist in employee benefits and auto-enrolment, uses them for its master trust.

Craig Harrison, managing director, says: “The benefit of target date funds versus lifestyling is that quite often in a GPP it’s very difficult to change your retirement date. It’s made up of different underlying funds, it’s not a case of a fund switch. 

“Say, for example, you’re in the Scottish Widows default fund, you will be invested in four different funds.

“Target Date Funds allow you to hop from one to the next if you want to change when you want to retire - you would be invested in one fund but that fund itself would be invested in four different funds.”

There are still risks involved with TDFs, however.

Mr Harrison says: “If you have a TDF with 30 years to go, you will be necessarily invested in equities, and gradually de-risk over that 30 years.

“The key thing is to get the asset allocation correct and you don’t want to leave the de-risking phase too late because the client could have a nasty shock if you have a 2008 to 2009 scenario, and you’ve got 13 years to go.

“The key thing is to make sure they’ve got the glidepath right.”

Easy to understand

Perhaps the biggest selling point about TDFs is that they make pension saving easy to understand. Mr Todd says that traditional lifestyling involves people having an active interest in understanding what low risk and high risk assets are. 

“But with TDF they can focus on the important things about investing. For example, we expect you to retire in 2030 or 2040, according to that target. If that doesn’t feel right for you, you can change to a different year, and there’s no fear of changing.

“It gets people focused on long-term saving without having to go into detail about what happens when you’re in your thirties."

He notes: “There’s a real communication benefit.”

How TDFs have performed will be covered in the next feature.

melanie.tringham@ft.com