Target Date Investing

The power of target date funds

Target date funds (TDFs) have transformed retirement investing. Diversification is one of the critical variables affecting employees’ retirement outcomes. TDFs seek to maximize employees’ likelihood of investment success by automating the investment process — from asset allocation to rebalancing — giving employees a single investment that may be suitable from the first day of work through retirement.

We design our TDFs to achieve that goal while balancing the trade-offs employees face as they invest for retirement, including managing exposure to market risk and longevity risk. Our approach to TDFs focuses on three primary considerations:

Outcomes
What are your employees’ income needs?

Risks
How do you want to balance market risk and longevity risk?

Exposures
How do you pursue strong investment performance while minimizing costs?

Our target date solutions employ factor-based investment strategies, which we believe are ideally suited to the long-term, low-turnover approach typical of retirement investors. Our TDF glide paths are based on sophisticated, proprietary analytics that strive to identify the glide paths with the greatest potential to achieve successful outcomes while managing the key risks to retirement investors.

We will work closely with you to identify the target date solution that could meet the needs of you and your employees and potentially produce better outcomes in retirement.

Target date in focus

Portfolio Manager Christian Chan and Head of Defined Contribution Nate Miles discuss the unique thinking and rigorous process employed in our target date funds.

Target Date in Focus

Nate Miles, CFA: Our target date fund offering here at Wells Fargo Asset Management is differentiated in three key ways, really. The first is our focus on outcomes. We’re trying to target 60 to 80 percent income replacement ratios for the end employee. Secondly, it’s our focus on risk: how much risk to take across a glide path, paying particular attention to those ages in or around retirement. And finally, it’s our focus on exposures, not just the evolution of the asset allocation over time, but really how are you getting your exposure to things like equities or using factor-based investing, or fixed income on the corporate side, where we’re looking at trying to provide more diversification and maintaining liquidity for the underlying securities.

Christian Chan: So we take one glide path and then we throw 10,000 economic scenarios at it. Then we create that range of potential outcomes for a glide path using accumulation risk, shortfall risk, market risk, success rate risk. We do that for every glide path that is possible. So that's 18,000 glide paths. Think about the math on it. It's 18,000 glide path, 10,000 scenarios. It takes a long time.

That's why I like to say that our target date strategies are really well balanced in terms of their ability to balance both accumulation risk and market risk. Because those tradeoffs are really explicit for us. We're not backing into this in any way. It is looking at the glide path that we think gives us the best balance of all of these different risks.

Nate Miles, CFA: I think the future of target date funds are going to evolve the focus more on the other side of retirement, the drawdown side. I think we’ve done a really good job of coalescing around what success looks like for the first 40 years of your working career. We’ve struggled to properly identify what does it look like beyond 65. That’s where we’re spending a lot of our time. That’s where our clients are asking us to focus increasingly. I think that’s where you’re going to see a lot of innovation over the coming quarters and years and certainly where we expect to provide the most improvements to our funds.

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Guiding principles

Two components are critical to the success of TDFs:

  • A glide path that effectively manages the balance between longevity and market risk, developed using a robust evaluation process
  • Exposure to factor-based investing that seeks to maximize effectiveness of meeting the investment objectives

We build our target date glide path on rigorous analysis. Our proprietary Glide Path Success (GPS) scores are used to evaluate 1,800 potential glide paths. The GPS scores seek to understand the risk trade-offs throughout the life cycle of the fund — from accumulation through retirement.

The glide path

We build our target date glide path on rigorous analysis. Our proprietary Glide Path Success (GPS) scores are used to evaluate 1,800 potential glide paths. The GPS scores seek to understand the risk trade-offs throughout the life cycle of the fund — from accumulation through retirement.

GPS scores evaluate the glide path’s effectiveness at reaching 80% income replacement for the average employee (using both savings and Social Security), the degree to which it might exceed that 80% target, and the risk that employees may fall below the target replacement rate, to name a few areas of evaluation. GPS scores inform our glide path construction.

Factors

Our TDFs take a factor-based approach to security selection and portfolio construction in order to address the needs of long-term investors. Factors are persistent and identifiable traits that influence investment returns. Examples include value, momentum, quality, low volatility, and size. Our factor-based approach seeks better risk-adjusted returns than traditional indices by emphasizing securities that provide exposure to these factors.

Our research indicates that factor-based investment approaches may be especially well suited to long-term, low-turnover investors — people like the employees who hold TDFs in DC plans.

The high adoption rate of target date funds

The Employee Benefits Research Institute (EBRI) reports that more than half of 401(k) participants invest in TDFs, including nearly 60% of recently hired employees.* As TDFs take center stage in retirement plans, we are committed to empowering these solutions to deliver the outcome that matters most to employees: income in retirement.

*Source: EBRI. “Target Date Funds Widely Used by Younger Plan Participants”. View Press Release.

Finding the right fit for your target date needs

We offer a range of target date solutions, including strategic, dynamic, and custom. We will work with you to pursue aligning your desired outcomes with a potential solution. Take a look at our target date fund lineup, or read more about our various approaches below.

Factor-based approach

Our flagship TDF is designed to manage key retirement risks for a typical employee retiring at 65. It employs innovative factor-driven indexing to seek strong risk-adjusted returns with low costs. As retirement approaches:

  • The risk of the equity portfolio declines modestly as it becomes more sensitive to the participant’s liability stream, which is dollar-denominated and inflation-sensitive.
  • The fixed-income portfolio tilts toward intermediate U.S. government bonds to manage interest rate and credit risk.

Factor-based target date funds glide path illustration

The glide path illustration shows that as retirement approaches, the equity portfolio declines and shifts more heavily to fixed-income investments.

A dynamic approach

For all their potential benefits, TDFs are managed in much the same way they were at their introduction more than 20 years ago. Our factor-based dynamic TDFs incorporate lessons learned from the global financial crisis, with features that seek to minimize the impact of down markets while capturing upside opportunities over the long term.

TDFs typically reach for higher equity allocations and greater market risk during the accumulation years. But they have to contend with the reality that market downturns are inevitable and unpredictable.

Most TDFs are constrained by a fixed glide path that steadily shifts away from risky assets over time but is unresponsive to the market environment. When equity markets are strong, these funds typically are positioned for growth. When equity markets decline, they are vulnerable to major losses. Our factor-based dynamic TDFs employ tactical asset allocation, volatility management, and tail risk management, with the goal of responding more effectively to market risks. Factor-based dynamic TDF features include:

  • Tactical asset allocation, emphasizing assets with higher expected returns or lower expected risks
  • Volatility management that increases equity exposure in low-volatility environments and decreases it in high-volatility environments
  • Tail risk management that reduces exposure to risk assets during market downturns

Custom target date solutions

Many employers have begun to identify unique needs among their plans and employees, which may arise due to distinctive workforce demographics or other reasons. Custom target date solutions may help meet those specific needs. We work closely with plan sponsors to identify the pros and cons of customization, performing the objective analysis they need to inform their decisions.

A variety of factors may call for considering customization, including:

Divergence
Do employees’ characteristics diverge from standard assumptions?

Homogeneity
Are those characteristics reasonably homogeneous within the plan’s population?

Significance
Are the divergences significant enough to warrant a custom solution?

Your team of experts

Our Multi-Asset Solutions investment team and our DC plan experts can help you identify investment outcomes you may want for your plan as well as identifying potential plan design improvements.