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Target Date Fund Investors Take Volatility in Stride

Market volatility affected recent performance, but investors continue to stick with TDFs.

Target date funds (TDFs) are designed for the long haul, allowing workers to build a nest egg – potentially throughout several decades – to be used during their retirement years. As such, it’s important to check how investors are utilizing these funds, especially during rocky market environments.

One of the first tests the majority of TDFs faced was the global financial crisis. During this difficult period, when the Dow Jones Industrial Average declined by 54% from its peak in October 2007 to March 2009, all TDFs posted negative returns. Relative results among TDFs were mostly driven by their level of equity exposure. The resulting losses prompted some people to criticize TDFs for not providing better protection during market drops, particularly for investors closest to their retirement dates.

The global financial crisis precipitated intense scrutiny of the TDF industry and a push for increased education on the role and risks of TDFs. Many investors were surprised to learn that their TDFs held significant stakes in equities and that their retirement accounts were at risk of such steep losses. But it was not just the losses that rang alarm bells. Plan sponsors were also worried that TDF investors would sell out of their funds during equity market lows – thus locking in those losses – and move their assets to less volatile asset classes, like fixed income and cash. In 2010, the Employee Benefits Security Administration (EBSA) proposed adjustments to its disclosure requirements for TDFs, including adding disclosures relating to volatility risk. And in 2013, the Department of Labor issued a set of best practices for TDF evaluation and selection in its “Target Date Retirement Funds: TIPS for ERISA Plan Fiduciaries” publication.

More than five years have passed since the global financial crisis and inflows into TDFs continue to be high. Furthermore, TDFs continue to be the most commonly selected qualified default investment alternative (QDIA) among plan sponsors. Many equity-heavy TDFs, which generally suffered the most during the downturn, were richly rewarded in the following years, as stock markets rose beyond their 2007 levels. During this time, several providers adjusted their TDFs, some increasing the equity exposure of their funds, others tweaking the underlying asset classes.

Given the relatively high level of volatility in the market thus far in 2015, PEI examined the performance drivers of TDFs during the first nine months of the year to see what has been impacting recent results. We also looked at participant behavior to make sure investors are still using TDFs appropriately.

Market Performance Drivers

Figure1: Quarterly Year-to-Date Asset Class Returns (%)

Asset class results noticeably jumped around during the first three quarters of 2015. As Figure 1 (to the right) illustrates, asset classes that started the year strong, such as REITs and international stocks, reversed course by the second or third quarters. Core bonds, as measured by the Barclays U.S. Aggregate Bond Index, was the only asset class to post a positive return year-to-date through September 2015. Emerging-markets stocks and commodities, asset classes that have been added to several TDFs in recent years, were especially hurt during the third quarter by market fears of a slowdown in China.

Effects of Market Movements on TDFs

Unsurprisingly, TDFs with relatively high exposure to the poorer performing asset classes, such as commodities and international stocks, have posted relatively poor performance thus far in 2015. In contrast, TDFs with a larger average allocation to core bonds have done relatively well.

Year-to-Date Return vs. Commodities or International Stocks Exposure

Figures 2 and 3 (above) and Figure 4 (below) highlight the correlation of average TDF returns with exposure to commodities, international stocks, and core bonds. (TDF returns and exposures were calculated by averaging returns and exposures, respectively, across the oldest share class of each TDF series.)

Year-to-Date Return vs. Core Bonds or Growth-Seeking Assets Exposure

As illustrated, sub-asset class exposures can have a material effect on short-term results. To be sure, there are a myriad of other factors, including overall growth-seeking assets exposure (which PEI identifies as equities, commodities, real estate, high-yield bonds, and emerging-markets bonds), performance of underlying strategies, and fees, which will also effect results. For example, as demonstrated by Figure 5, TDFs with larger allocations to growth-seeking assets have generally outperformed during the trailing five-year period, when markets have mostly been on the rise.

Participant Behavior

Importantly, TDFs remain a capable investment option for helping participants invest for retirement. By offering a well-diversified product and incorporating various plan design features, such as auto enrollment and paycheck deduction, plan sponsors can support their workers as they are saving and investing in their future.

In addition, investors in TDFs tend to stick with their investments and benefit from their steady contributions. Research from Morningstar shows that, unlike investors in single asset class options who tend to move in and out of asset classes at inopportune times and therefore miss out on some of the returns of those asset classes, TDF investors generally have better results than the investments themselves.[1]

Indeed, net flows to TDFs have been consistently positive, while flows to other assets classes have changed direction over time. As depicted in Figure 6 below, even during 2008’s downturn, TDFs continued to grow in assets by receiving net inflows while other asset classes experienced withdrawals.

Inflows to TDFs have remained strong year-to-date, confirming that, in aggregate, participants continue to be unfazed by the market volatility. Instead, participants are using these investments for the long haul they are designed for.

Calendar Year and Year-to-Date Net Flows by Asset Class

More so, PEI has learned through discussions with many large service providers that the volume of investor phone calls into their call centers rose dramatically in August 2015, when markets were most volatile. However, investor activity – such as making liquidations and making exchanges into other funds – did not rise noticeably. According to the majority of service providers contacted, less than 1% of participants made any changes to their portfolios, which was consistent to that of 2008. This data confirms the importance of continually educating participants on what to expect from their TDFs so they can evaluate the performance of their accounts within the context of market volatility and their long-term retirement goals.


Since 2008, there has been heightened scrutiny of TDFs and their ability to provide investors with a way to successfully save for retirement. Short-term market volatility can cause dislocations in relative performance of each fund, and understanding that performance in context is important. While some plan sponsors have worried that market jitters will drive participants to abandon their TDFs, that has not been demonstrated, as TDFs continue to grow in assets from investor contributions. Plan sponsors should be mindful of the exposures of their plan’s TDFs as they review performance, and also work with their service providers to ensure participants are also adequately equipped to continue to make informed investment decisions

[1] Morningstar, 2015 Target-Date Fund Landscape.