While many experts are calling for a more conservative investment approach for target-date funds, an Australian academic is arguing that in many cases equity allocations should be increased from current levels for participants approaching retirement.
At last month's joint Department of Labor and Securities and Exchange Commission hearing on target-date funds, also known as lifecycle funds, Michael Drew, a professor of finance and economics at Griffith University, Brisbane, Australia, testified that asset allocations should be based on the size of the participant's account, not on his or her age. Because the bulk of the growth in accumulated wealth takes place in the plan participant's later years, the funds should adopt a more aggressive asset allocation closer to the target retirement date, he argued — the opposite of the strategy employed by most target-date funds.
“The portfolio size effect shows that many of these funds de-risk at precisely the wrong time,” Mr. Drew said in an interview. “Looking back over the past 40 years, it doesn't matter what you do with the assets for the first 20 years, it's such a small amount of money. It's what you do with the largest amount of money that matters.”
Other target-date experts — well aware of pressures on Capitol Hill to restrict equity allocations for funds that are approaching their target date — disagreed.
Anne Lester, managing director and senior portfolio manager of the global multiasset group at J.P. Morgan Asset Management, New York,agreed that shifting to more conservative assets might not enable every participant to reach their retirement goals, but said employers and managers could add fiduciary risk by acting too aggressively. “Each fiduciary has to grapple with that question. We have always felt that the glide path needs to be conservative approaching retirement because the potential negative consequences of very aggressive investing near retirement are too high, with 2008 really illustrating that.”
In a recent paper, “Portfolio Size Effect in Retirement Accounts: What Does it Imply for Lifecycle Asset Allocation,” published in April in the Journal of Portfolio Management and co-authored by Anup Basu of Queensland University of Technology, also in Brisbane, Mr. Drew argued the widely accepted practice of decreasing an investor's exposure to risky assets on the basis of age is flawed.
Messrs. Drew and Basu created two hypothetical investors with a 40-year investment horizon. One contributed to a fund with a lifecycle strategy, in which the mix of assets gradually switched from a stock-and-bond mix to an all-bond-and-cash portfolio for the participant's final 20 years of employment. The second participant followed a contrarian strategy, starting in cash and bonds and after 20 years moving to a 100% stock allocation for the final two decades of employment. For each year, Messrs. Drew and Basu randomly chose a year between 1900 and 2004 of returns from U.S. stocks, bonds cash, doing this 10,000 times to produce 10,000 outcomes.
The result: The median final wealth of the contrarian investor was 12.5% higher than the median outcome for the lifecycle target-date fund participant. The lifecycle strategy outperformed only when the researchers compared the bottom decile of the respective groups (meaning these outcomes have a one in 10 chance of occurring).
“We're not advocating the contrarian strategy,” Mr. Drew explained. “We just wanted to demonstrate how irrational it is to de-risk too soon. Just because you have a birthday, you shouldn't compromise your long-term investment performance. The last thing financial planners would say today is to sell your stocks, but that's what's happening in many lifecycle funds.”