Learning From Target Date Funds Without Actually Using Them

The Wall Street Journal recently wrote about the extent to which Target Date funds are starting to incorporate liquid alternatives “in hopes of steadying performance with assets that may not move in lock step with mainstream stocks and bonds.”

For anyone who doesn’t know, Target Date funds are designed to offer a core solution that adjusts asset allocation in line with its target date. A 2016 target date fund would likely have very little in equities because the assumption is that the person buying it would be retiring in 2016 where a 2045 target date fund would likely have a heavy exposure to equities on the assumption that the person buying it would be retiring in 2045.

I believe that target fund managers allocating to alternatives at the expense of fixed income, keep in mind the percentages are small, is very interesting as well as telling about their expectations for traditional fixed income in the years to come.

Yields generally fell for more than 30 years which is something that can’t be repeated from here. It would seem like rates have to go up from here even if we aren’t sure when that actually starts but even if that doesn’t happen, if rates churn around in the same narrow range that they have been for the last year or so then the dilemma of low yields still exists and the threat of higher yields would also still exist.

This is part of the logic underlying my long held belief for having a small allocation to alternatives (in years past I referred to them as diversifiers).

The fund marketplace, as we’ve talked about before, is offering more alternatives, some of which will work well and some probably will not. Additionally there are now more unconstrained bond funds coming to market that also try to address this issue.

While I am on board with the idea of modest use of alternatives I have never been a fan of target date funds. Each provider tend to have different ideas about how to move along the glide path from more equities to more fixed income and those differences led to a lot of surprises during the great recession and it is a good bet there will be a lot of surprises whenever the next bear market comes along.