Valuable Lessons:
A Look at US Target-Date Retirement Funds

By Alistair Lowe, Chief Investment Officer, Global Asset Allocation & Currency,

State Street Global Advisors

The challenge in designing the investment objective for a DC scheme's default fund is to balance risk, return and varying outcomes. Complicating matters further is the fact that investment objectives and risk tolerances evolve as members move towards retirement. Offering a suite of target-date funds as the default option may be the best solution available.

The overarching objectives of target-date funds are to follow the evolving needs of their ageing member base and to focus on addressing the critical risks that their members may face during their pre and post-retirement years. As members go through their accumulation or savings phase, for example, the funds should address the risk of not generating sufficient portfolio growth to support retirement. Funds designed for younger members should have a high equity allocation and focus on capital appreciation.

The years just before retirement, sometimes referred to as the "retirement risk zone", represent an important phase in the retirement savings process. Significant portfolio losses in the years immediately before and after retirement can be catastrophic. For this reason, a prudent asset allocation should reflect a clear transition from the accumulation to the preservation of assets. This is especially important in the UK where annuitising accumulated assets is still common practice.

In countries like the United States where annuitising assets is far less common, people face longevity risk, i.e., the risk of outliving their assets; inflation risk that could cause their assets to lose their purchasing power; and the risk of wealth degradation in down markets. These risks have a profound impact on the ability of an individual's accumulated wealth to provide sufficient retirement income.

To balance these sometimes competing factors, asset allocation models that target higher levels of risk and return over long time horizons allow members to weather short-term market downturns. Conversely, controlling risk in later years when members are at or near retirement is equally important. At that point, wealth preservation becomes a primary objective. The two key drivers behind accumulating wealth during a member's working years can be broadly segregated into level of savings and return on investment. As a result, quantifying various replacement income probabilities and communicating them to members becomes an important aspect of fund management.

Offered as a suite of funds, target-date funds seek to provide investors with convenient, cost-effective exposure across major global asset classes within a single investment option. These funds combine diversified investment portfolios, professional portfolio management and automatic rebalancing based on risk and return goals over a long time horizon.

Target-date funds simplify the investment decision-making process for members at enrolment and, more important, they simplify the rebalancing process throughout members' working years and into retirement. These funds are appropriate for a wide range of members and solve some of the most common problems sponsors and members encounter by:

• Increasing participation rates due to ease of use
• Creating more diversified portfolios for members
• Ensuring an appropriate risk level for members based on retirement date
• Ensuring disciplined rebalancing to an appropriate asset allocation

Target-date funds offer trustees a compelling solution to these problems. By delegating asset allocation and long-term planning decisions to the investment manager, scheme members can avoid common retirement investing mistakes and increase the likelihood of reaching their retirement income goals simply by selecting an expected retirement date.

State Street Global Advisors Limited. Authorised and regulated by the Financial Services Authority. Registered in England. Registered No. 2509928. VAT No. 5776591 81. Registered office: 20 Churchill Place, Canary Wharf, London, E14 5HJ n Telephone: 020 3395 6000 n  Web: www.ssga.co.uknFacsimile: 020 3395 6350

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