While they’ve long existed in the U.S., Canadian investors have had access to Target Date Funds (TDFs) for less than a decade. Those TDFs reporting to the Investment Funds Institute of Canada (IFIC) had assets of $4.1 billion at the end of March 2010. They’re reasonably popular but they’re not yet a smashing success with retail investors.
TDFs, as the name suggests, sets a maturity date between 5 and 20 years into the future. The mix of stocks, bonds and cash (i.e. asset mix) is more aggressive for longer-dated funds and more conservative for shorter-dated funds. As time marches on, the assets mixes of the respective funds grow increasingly conservative so that the funds are nearly fully invested in cash within a year of the maturity date. Some funds will ‘roll over’ into a payout fund, which will pay out the full value of the fund over time. While buying a fund with a time horizon that lines up with your client’s investing horizon has intuitive appeal, it’s nothing more than a short-cut solution wrapped in marketing fluff.
An investor’s asset mix should be driven by future spending targets (i.e. liabilities). Once those future liabilities are clearly defined, with associated time frames, the investor’s assets can then be invested to ensure that assets are well-matched to those liabilities. The overall asset mix resulting from this liability-matching should be evaluated for consistency with the investor’s capacity & willingness to assume risk – then structured in a way that is sensitive to the investor’s tax situation, legal circumstances and other structural factors (i.e. asset location).
By contrast, TDFs simply offer investors an asset mix based on a set time horizon without regard to liability-matching and the other important variables that should define the asset mix. I’m turned off of TDFs based on that alone. But innovations like guarantees simply worsen an already mediocre product.
When the equity component of a guaranteed TDF falls in value, the fund could be forced to add to its bonds to cover the guarantees promised by the guarantor. Yet, when stocks fall in value, it can make more sense to rebalance in an effort to enhance recovery potential and boost long-term performance. By not rebalancing – or worse, monetizing or going all to cash and bonds – protecting the investor becomes secondary to protecting the guarantor’s promised capital guarantee.
Buying a portfolio without regard to client goals and robust profiling raises the likelihood of having a disappointed client. And nobody wins in that scenario.