A target date fund is an investment fund that is tailored to a pension scheme member’s particular date of retirement.
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- Target date funds are investment funds tailored to a pension scheme member’s date of retirement.
- Most target date funds are written to a three-year band, such as 2028 to 2030, rather than one specific date.
- Funds gradually de-risk, reaching their most conservative point at the target date.
Designed as a single fund for life, it is risk-managed from the day an employee starts contributing to a pension through to the day he or she retires.
In the US, target date funds gained popularity after it introduced its version of auto-enrolment under the Pension Protection Act of 2006. The Department of Labor Qualified Default Investment Alternatives rules, published the following year, mentioned target date funds as eligible default funds.
In the UK, the National Employment Savings Trust (Nest) uses target date funds as its default option. So why are these funds attracting so much interest?
Tim Banks, director of DC [defined contribution] sales and client relations at investment management firm AllianceBernstein, says: “In the past five years, we have seen very high volatility in equities coming down to low volatility, but we have also seen interest rates and long-dated UK government bonds at historically low levels. The ability to be able to proactively manage the risks inherent in the funds by using a target date fund with a portfolio manager which can trade daily is increasingly important in the current investment environment.”
Flexible route to retirement
However, following the removal of the default retirement age in April 2011 and with many employers wanting to offer staff a more flexible route to retirement, it no longer seems practical to choose a set retirement date.
Laith Khalaf, pension investment manager at Hargreaves Lansdown, says: “The UK workforce has historically had a default retirement age of 65, so you could bet that a large proportion would retire at 65. But that is not the case any more. This idea of a single point of retirement is pretty much out the window.”
Most target date funds are written as a retirement window, such as 2028 to 2030, rather than one specific date. Henry Cobbe, managing director at target date fund provider BirthStar, says: “It draws a line in the sand that marks out [an employer’s] likely retirement window, which can, of course, be changed.”
Target date funds can also have mechanisms that increase the complexity of the investment instruments that are used without exposing members to this complexity.
Manage risks better
Banks adds: “There may be many things going on ‘under the bonnet’ [of the fund] to help members get a better outcome or to manage risk better. However, members don’t have to engage with that investment sophistication if they don’t want to.”
Target date funds gradually de-risk over time, reaching their most conservative point at the target date itself, so the de-risking process is embedded in fund level and asset location decisions, rather than traditional lifestyling.
Cobbe adds: “Dynamically managed target date funds can take into account market conditions and introduce more governance and oversight into how people’s money is invested.”
As with any default fund, the key risks that individuals will face are considered, including downsides in the performance of capital markets, ongoing volatility and inflation.
Will Allport, vice-president of DC at investment firm Pimco, says: “The funds create a mechanism through which [members] can imbed the kind of protections they need against volatility, downside risk and inflation. [Any strategy] must be robust to a range of retirement dates.”