Insight post

Jan. 26, 2016

Examining Effectiveness of Target Date Funds

Target Date is Out of Date

Easy Does It or Easy Doesn’t Do It?

It’s fair to say that most people like when complicated concepts or difficult tasks are ‘made easy’.

It’s also fair to say that the two biggest innovations in managed financial products over the last two decades are exchange traded products (ETPs) and target date funds. Little surprise there.

But how have some of these ‘made easy’ products delivered upon their expectations over time?

According to Morningstar’s “2015 Target-Date Landscape” report, there is an estimated $700bn of assets under management in target date funds, up from $100bn a decade before. In addition, there is an estimated $300bn in collective investment trusts (CITs) that are invested along the same lines as target date funds. This adds up to $1 trillion of assets and some experts expect that number to double to $2trn within the next several years. (Source: “Target Date Funds Take Over,” Barron’s, July 5, 2014, Andrew Bary)

Net Assets Flow into Target Date Funds - Morningstar - Swan Insights

Retirement Investing ‘Made Easy’ — Target Date Funds

Certainly having a “one-click solution” for defined contribution plan participants offers a lot of advantages. According to a May 2015 report from the Government Accountability Office, 52% of households over the age of 55 have no 401(k) or IRA savings, and of the 48% who do the median value is only $109,000. Given the widespread financial illiteracy and low savings rates of the average American, making the process of saving for retirement as easy and painless as possible is an attractive proposition. (Source: “Retirement Security: Most Households Approaching Retirement Have Low Savings”)

The concern, however, is that by utilizing a “painless” solution at the outset, investors are setting themselves up for pain in the future.

  • Can target date funds deliver enough growth to fund an average investor’s retirement?
  • How well have target date funds protected capital?
Made Easy Products May Make Retirement Not So Easy

Unfortunately, the track record of the average target date fund has been underwhelming. The graph below shows the risks and returns across several “vintages” of Morningstar category average target date funds, versus the DRS.

Risk-Return Target Date Fund Series - Morningstar Category Averages - Swan Insights

Source: Zephyr StyleADVISOR, Swan Global Investments

Certainly, the risk has increased across the spectrum as one moves from conservative to aggressive. But what has been lacking is a corresponding increase in returns. It is unlikely that returns in the 5% range were what investors in these products were anticipating. However, what is perhaps more concerning is how target date funds performed during the big equity bear markets.

Historical Drawdowns 1997-2017 - Target Date Fund Series - Morningstar Category Averages - Swan Insights

Source: Morningstar and Swan Global Investments, LLC

The above chart details the peak-to-trough losses of the average target date funds over the last 18 years, versus the DRS.

Of particular concern is the performance of the average Morningstar Target Date 2000–2010 fund during the 2007-08 correction. These portfolios were some of the most conservative target date funds available, positioned as appropriate for someone who was planning on retiring sometime between the year 2000 and 2010. And yet when the credit crisis hit in 2007-08 these funds lost an average of 31.03%. They spent a full three years underwater before recovering their losses. Many Americans were hit doubly hard during this period, where their investment losses were paired with unemployment, stagnant wages, falling home values, or other financial challenges.

Another Way to Make It on Target

The poor performance of the target date funds, especially during the two major bear markets since 2000, highlights one of the core tenets of Swan Global Investments’ philosophy.

We believe that traditional asset allocation and diversification fails to sufficiently protect wealth during periods of severe market downturns.

After all, the textbook descriptions of asset allocation often state that market risk, or systematic risk, simply cannot be diversified away. The vast majority of target date funds seem to passively accept this risk by holding the vast majority of their assets in simple stock-bond combination.

Asset Allocations - Target Date Fund Series - Morningstar Category Averages - Swan Insights

Source: Morningstar and Swan Global Investments, LLC

The Defined Risk Strategy differs from this passive approach. The DRS takes an active role in confronting market risk and does so via clever hedging strategies. Our distinct investment approach has been applied to a range of asset classes in a suite of DRS mutual funds.


Originally applied to U.S. large cap stocks in 1997, the DRS is now available on U.S. small cap stocks, foreign developed market equities, and emerging market stocks.

Moreover, Swan Global Investments in conjunction with Gordon Asset Management has recently unveiled a family of collective investment trusts (CITs) utilizing the DRS. Given target date funds’ poor performance based upon traditional asset allocation described previously, we believe the DRS addresses the biggest shortcoming in an otherwise practical idea.

The myriad of problems facing baby boomers as they enter retirement are explored further in the Swan white paper, “The Retirement Conundrum: Untying the Gordian Knot.”

About the author:

Marc OdoCFA®, CAIA®, CIPM®, CFP®, Director of Investment Solutions, is responsible for helping clients and prospects gain a detailed understanding of Swan’s Defined Risk Strategy, including how it fits into an overall investment strategy. Formerly Marc was the Director of Research for 11 years at Zephyr Associates.

Important Notes and Disclosures:

Swan Global Investments, LLC is a SEC registered Investment Advisor that specializes in managing money using the proprietary Defined Risk Strategy (“DRS”). SEC registration does not denote any special training or qualification conferred by the SEC. Swan offers and manages the DRS for investors including individuals, institutions and other investment advisor firms. Any historical numbers, awards and recognitions presented are based on the performance of a (GIPS®) composite, Swan’s DRS Select Composite, which includes non-qualified discretionary accounts invested in since inception, July 1997, and are net of fees and expenses. Swan claims compliance with the Global Investment Performance Standards (GIPS®). All data used herein; including the statistical information, verification and performance reports are available upon request. The S&P 500 Index is a market cap weighted index of 500 widely held stocks often used as a proxy for the overall U.S. equity market. Indexes are unmanaged and have no fees or expenses. An investment cannot be made directly in an index. Swan’s investments may consist of securities which vary significantly from those in the benchmark indexes listed above and performance calculation methods may not be entirely comparable. Accordingly, comparing results shown to those of such indexes may be of limited use. The adviser’s dependence on its DRS process and judgments about the attractiveness, value and potential appreciation of particular ETFs and options in which the adviser invests or writes may prove to be incorrect and may not produce the desired results. There is no guarantee any investment or the DRS will meet its objectives. All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is not a guarantee of future results and there can be no assurance, and investors should not assume, that future performance will be comparable to past performance. All investment strategies have the potential for profit or loss. Further information is available upon request by contacting the company directly at 970–382-8901 orwww.www.swanglobalinvestments.com016-SGI-012016