A target date fund is a fund where the investments are optimised to achieve a specific goal at a future point in time; for most people this is retirement date. The fund structure rebalances automatically depending on how close a person is to retirement.
TDFs are extremely good for environmental, social and governance considerations in retirement planning as unless one has a lot of time and determination, constructing a balanced and evolving ESG retirement portfolio is an almost impossible challenge for both an adviser and an individual.
The problem is compounded by the fact that ESG investment extends beyond the investment itself and applies to all participants in the process. For example, an investor may not want to purchase an ESG-compliant investment from a business that does not use similar ESG policies.
While there is increasing information on funds and an almost daily launch of a new ESG option, the reality is that trying to construct a glide path to retirement that includes retail investments that are ESG is almost impossible.
For this reason, ESG within retirement planning is arguably best served by the use of TDFs. And, for much of the insight, we need to look to the USA where they have been commonly used for almost 30 years.
TDFs are not as new as people might have you believe. They date back to 1994 when Barclays Global Investors and Wells Fargo launched them to address 401k issues in the US.
These issues remain today and fundamentally revolve around the fact that planning for retirement requires a strategy that includes using assets with different risk and rewards over the pre-retirement investment journey. It is also worth noting that similar issues exist in decumulation investment strategies, but this CPD only looks at TDFs and accumulation to retirement.
DIY retirement planning the problem
TDFs solve a problem that largely did not exist in the UK until relatively recently. Ignoring ESG for the moment, those who were lucky enough to be in a defined benefit or defined contribution workplace auto-enrolment scheme, often using a master trust structure, had their retirement planning managed for them.
The relatively small number of people with personal pensions was fairly well catered for with their current provider or one of the DIY investment platforms, albeit they needed to manage their own glide path to retirement. It should be noted that in the US a good proportion of this DIY market adopted a TDF solution when it became available.
However, the 5m self-employed workers in the UK (up from 3.2m in 2000) have largely been ignored. This problem is compounded by the fact that we have a burgeoning gig economy, where almost 4.5m people regularly find work through online platforms in England and Wales. I should stress that there is a huge overlap as 48 per cent of gig workers also have a full-time job.
TDFs’ core principle is often called a glide path to retirement. Quite simply, it is based on an investment manager ensuring an appropriate asset allocation given someone’s time to retirement. Within this, it is the need to ensure the balance changes over time.