Graphic: The risk in target-date funds
Target-date funds’ popularity has exploded since the end of the financial crisis, and for good reason. They offer a set-and-forget investment option that allocates and adjusts assets to meet investors’ risk and return priorities over their investment horizon. While equity allocations are greater in longer-dated funds, and therefore riskier, often overlooked is how the contributors to risk differ among providers.
Big growth: PSCA found 73% of 590 DC plans surveyed offer target-
date options, and about 22% of all DC assets were invested in TDFs at the end of 2016. As of March 2018, TDFs had about $1.5 trillion in assets, up from $200 billion in 2008.
Risk's source: Morningstar decomposed equity risk into three factors: market, style and selection. Each factor’s contribution to risk was averaged across all funds, showing broad equity allocation (market) as the prime mover of total fund risk.
Style, selection matter: Morningstar then examined the relative risks across the return factors and found that decisions made by individual managers on style and selection contributed more to returns than broad equity allocation.
Active decisions: The Morningstar study compared the coefficients over consecutive five-year periods to gauge how active* TDF managers are. The more active managers change their exposures or allocations more often, requiring more oversight.
*Does not pertain to the use of active or index strategies in the funds. Research based on 10 largest TDF series. Sources: Bloomberg LP, eVestment LLC, Morningstar Inc., Plan Sponsor Council of America, with thanks to David Blanchette at Morningstar.
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