Target date funds (TDFs) offer DC plan members a single, convenient investment solution. An asset allocation trajectory known as a glide path automatically and gradually shifts from a focus on capital growth to one of capital protection as the fund approaches maturity.
The aim is to provide members with a degree of confidence that, on a certain date in the future, a portion of their retirement savings will be ready and waiting, just as they’d planned all those years before.
The glide path is typically built around a primary strategic allocation to equity and fixed income securities. It’s established when the fund is first launched, often based on simulation models that help guide the fund manager’s decisions.
Within each allocation, of course, fund managers have a wide range of strategic decisions to make about how to spread the investment dollars. From Canadian equity to global fixed income, to emerging market debt to real estate investment trusts (REITs), commodities and infrastructure—the list is long and growing.
However, markets don’t often align with best-laid plans. They don’t necessarily follow the direction of models. Market forces require fund managers to be flexible—to revisit, review and modify their views as part of their ongoing effort to best serve members.
One of the most powerful forces driving allocation decisions has been persistently low interest rates, particularly in North America. Though they’ve been edging higher recently, with the U.S. 10-year Treasury yield at roughly 2.5% (that’s about one percentage point higher than it was 12 months ago), interest rates have been hovering near record lows for half a decade.
For evidence, Morningstar Research notes in its 2013 Target-Date Series Research Paper that the number of U.S. target-date series with investments in emerging market bond funds doubled between 2008 and 2012, from nine to 18.
On the equity side, Morningstar observes that U.S. TDF managers have “significantly increased” allocations to non-U.S. equities relative to U.S. equities. The report finds that most U.S. managers who have increased their exposure to non-U.S. equities say they did so to “reflect the growing influence of international businesses on the global level.” While the Morningstar paper was confined to the U.S., it’s fair to consider the Canadian landscape in a similar light.
Funds are also taking on greater exposure to more alternative asset classes such as REITs and infrastructure. This can provide the more obvious benefits associated with investing in a mix of typically low correlation asset classes. But with these asset classes in particular, there is also the potential for a degree of inflation protection.
There has also been a steady rise of index-tracking funds within many target-date solutions. Having a mix of active and passive underlying funds—and the ability to manoeuvre between them based on market conditions—is a good approach.
Providers also need to review their own target-date platform, adjusting the asset mix to take advantage of what may be profitable investment opportunities in the years ahead. For example, allocations to emerging market debt and high-yield bonds can be added to further diversify TDFs’ internal income streams and potentially reduce volatility. Owning a broad basket of global bonds diversified by country, credit quality and duration is essential, given interest rate conditions around the world.
In addition to the pairing of active and passive, providers can add the ability to tactically shift between growth and value styles. Modulating style exposure is especially important during transitional periods in the economic cycle. Generally speaking, growth-oriented securities and value-oriented securities perform differently depending on economic conditions.
Industry providers must give plan members the best investment solutions. Markets change and flexibility is critical. Sometimes, to get the job done right, the industry needs to modify the tools.
Lori Landry is chief marketing officer and head of institutional business with Sun Life Global Investments. The views expressed are those of the author and not necessarily those of Benefits Canada.
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