Target-date Funds: Good News and Bad News

Abstract

Target-date funds are funds targeting specific retirement years. They are now included in many defined contribution pension plans and, in some cases, represent the default choice. We analyze the investment characteristics of these funds using the Center for Research in Security Prices mutual fund database for the period from January 2006 to May 2009, when we can correctly identify these funds. The most striking result is that the 2010 date funds significantly increased their common equity exposure in 2007, immediately prior to the stock market crash of 2008, resulting in significant losses for investors planning to retire in 2010. This is bad news in that, on average, target-date funds invested 75% in common equity, which generated average losses of 30% plus in 2008. However, we also find that, on average, the performance of target-date funds is consistent with greater risk and better performance for longer-dated funds, which is good news. We also find that this segment of the mutual fund industry is highly concentrated with the top three management companies controlling 81% of assets under management with a wide range of management fees, turnover, asset allocation and performance.

Keywords: target-date funds; pension funds; asset allocation

JEL Classification: G11