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White Paper

The Three Dos and Don’ts of Target Date Investing

22 February 2022
5 min read

 

At AB we have a clear mission for our target date funds (TDFs) and a roadmap for their future development. At each stage, we use three simple design principles that keep our TDFs focused on client needs, superior investment outcomes and value for money.

In the following sections we explain our three key dos and don’ts, and illustrate them with examples of recent developments in our TDF ranges.

1. Don’t Expect the Future to Look Like the Past

Many trustees are reconsidering arrangements for their DC plans, and contemplating switching to a target date approach and/or a master trust. The risk is that they choose an investment solution that worked well in the past but may not deliver the intended outcome in the future.

For instance, over recent decades simple passive equity/bond strategies have performed strongly. Now things are changing. Government bonds have become so expensive that it is mathematically impossible for them to replicate past performance. And equities have benefitted from benign growth and margin conditions that are starting to face headwinds. Recently, Russia’s invasion of Ukraine and the resulting far-reaching economic sanctions have rattled markets and fuelled inflation through soaring commodity prices. In the face of increased uncertainty and more challenging conditions in future, trustees will need better diversified investment solutions with more sophisticated risk controls (Display, below).

Real Return Expectations for Major Asset Classes
10 Year Median Return Expectations vs Last 10 Years
Real Return Expectations for Major Asset Classes

Past performance and current analysis do not guarantee future results.
As of 31 December 2021
All returns are in GBP.
Gilt forecasts are for UK government seven-year constant maturity bonds; global stocks’ forecasts are for a universe similar to the MSCI World Index. Global Corporate Bond forecasts and realized returns are both hedged to GBP.
Indexes used: MSCI World Net Return (NR), MSCI World Small Cap NR, MSCI Emerging Markets NR, FTSE EPRA NAREIT Developed NR, Bloomberg Global Aggregate Corporate Total Return (TR), FTSE Actuaries UK Index-Linked Gilts All Stocks TR, FTSE Actuaries UK Conventional Gilts All Stocks TR, ICE LIBOR 1 Week, UK Consumer Price Index (CPI).
An investor cannot invest directly in an index or average, and these figures do not include the sales charges or operating expenses associated with an investment in a portfolio, which would reduce total returns.
Source: Morningstar and AllianceBernstein (AB).

At AB we have created more broadly diversified risk-mitigating TDF strategies that are better able to cope with changing market conditions. Looking forward, we believe government bonds may no longer provide the same downside mitigation as in the past and are diversifying more widely across our TDFs’ defensive assets to keep our risk controls effective.

Environmental, social and governance (ESG) factors are becoming ever more important for investment outcomes too. Companies are increasingly being held to account for their ESG records. ESG leaders are generally rewarded with higher share prices and lower financing costs; ESG laggards face divestment campaigns and may struggle to raise new capital in future. Evaluating ESG factors represents an additional lens for assessing risk and return opportunities. That’s why ESG is fully integrated in our research process and responsible investment is an increasing focus in our TDFs. For example, we have:

  • Set carbon reduction targets across our TDFs of 50% by 2030 and net zero by 2050. As part of our Climate Change Action Plan, we’ve formalized a preliminary net zero roadmap detailing specific future research/action steps.
  • Maintained a low carbon equity allocation to reduce exposure to the carbon risks present within market-cap-weighted global equities.
  • Integrated a tilt to ESG by combining positive and negative screens. A positive tilt within our multi-factor equity allocation has improved the overall strategy’s ESG characteristics across the broadest range of metrics possible, including those related to carbon.
  • Accelerated the removal of controversial weapons with up to 95% of our allocations now excluding them, well on the way to our 100% goal. We also widened our exclusion list to encompass tobacco, thermal coal, and conventional/civilian firearms in recognition of heightened ESG risks amid ever growing consumer and government scrutiny of these activities: so far, up to 77% of our allocations make these further exclusions.
  • Leveraging our experience in integrating specialist active allocations, we began work designing a sustainable opportunities allocation for our TDFs. This allocation will invest in specialist ESG-oriented opportunities that are missed in traditional market exposures (for instance, sustainable housing REITs).
  • Refocused our open-architecture fund selection to include only managers with sufficient resources for efficient and sustainable voting and engagement processes over the long term. Correspondingly, when we make manager changes or implement new allocations, we consider ESG criteria as part of the selection process.

In future, regulators and markets will dictate even higher standards of responsible investing. So we are acting early to get ahead of these and other developments. Of course, not all changes are predictable. But we always aim to be as forward-looking as possible to help future-proof our clients’ portfolios.

2. Do Commit to Continuous Improvement

Change is a constant in both investment markets and in pensions regulation.

We are committed to improving our strategic asset allocations, investment process, and wider TDF proposition through time. Every year we draw up an Investment Agenda to address new investment approaches, long-term opportunities, and regulatory/market conditions changes. Our Agenda covers four broad categories: optimizing the level of risk taken; enhancing diversification and risk management; improving transparency for clients; and innovative product development. In this way, we can continually evolve our TDF ranges and ensure they are fit for future challenges.


In 2021, for the first time, we published our investment research agenda not only for clients but also their advisers.

In addition, we built a TDF strategy for a client that specified an explicit sustainable mandate. This strategy screens for several negative business activities. But over and above that, the strategy actively tilts to investments in products and services that align with the UN Sustainable Development Goals (SDGs) and in particular to three specific focus themes: climate, health and empowerment.


In 2020, we successfully pioneered a listed private equity allocation for a bespoke client as part of our open-architecture approach. In 2021, after appointing an independent specialist selection advisor, we have begun rolling out listed private equity for all of our TDF clients. We expect this will serve as a long-term return enhancer for younger members and will help to further diversify our growth assets.

A key part of continuous improvement is to make retirement planning (and in particular taking an income) as easy and straightforward as possible for members. For instance, we are leveraging our global expertise in managing assets for those saving for retirement and those in retirement, to develop more seamless products that can better support our clients and their members. These designs include an evolution of our existing income-for-life focused Retirement Bridge TDFs and an objective to provide a “default” option for post-retirement.

Our ultimate aim is to provide UK DC members with a pensions experience comparable to defined benefit schemes, combining: expert investment design; a flexible and low-cost structure; effortless participation; and a secure income for life. Building on our history of innovation and our expertise from the US market in creating guaranteed lifetime income solutions (Display, below) we are certain this ultimate goal is attainable.

AllianceBernstein: DC Leaders in Innovation
AllianceBernstein: DC Leaders in Innovation

For illustrative purposes only.
As of 31 December 2021. Source AB.

3. Do Stay Focused on Performance, Cost and Risk

Value for money (VFM) is a function of performance, cost and risk. Without good data for all three factors, any value assessment will be flawed.

Our fund ranges already provide transparency on all these factors for trustees and members. Because each member in the default option invests in a single TDF for their career lifetime, the reporting data we provide to our clients represents a summary of most members’ actual experience. Now we aim to gain a better understanding of all three factors for an even sharper focus on VFM, to enhance risk-adjusted returns and manage costs.

We have started implementing new systems that will enable complete look-through to underlying securities across all our allocations. Not only does this allow us to understand exposures at a more granular level and perform more detailed portfolio analysis, it also allows us to report on individual investment allocations and ESG metrics. In future, we plan to include top 10 security holdings on member factsheets (as opposed to fund/asset allocation), which we believe will be much more engaging.

The new systems will also provide clients with a wide range of ESG and carbon metrics for each of our TDF strategies. This will supplement the existing ESG policy, allocation and active ownership metrics/case studies that we already provide. Coupled with our commitment to analyse and mitigate climate change risks in our portfolios by understanding the science and applicability to financial markets, this technology will also allow us to support clients with the Task Force on Climate-related Financial Disclosures (TCFD) data and scenario analysis requirements that came into effect in October 2021.

Risk budgeting is central to our design process and the ongoing management of our TDFs. For each client we carry out a detailed analysis of their pension plan’s specific membership profile. Our proprietary analytical tool (AB CyRIL ) assesses their members’ current personal wealth, time horizon to retirement and ability to recoup from losses within that horizon. Based on these data we calculate a risk profile of the plan that we can compare with our TDF ranges. For large bespoke clients we can create a unique TDF range. This will optimize the risk budget for maximum return consistent with acceptable risk in line with their membership profile. For clients investing in our standard TDF ranges, we use the risk profile data to show how their membership fits with the existing risk budgets of our TDFs and what this means for the outlying members in their risk distribution.

AB CyRIL
Our proprietary analytical tools sets the investment objectives for our TDFs
AB CyRIL


 

Our Approach

Our approach contrasts with TDFs designed for lowest-cost investment components and/or comprising exclusively in-house funds. Neither approach is geared specifically to members’ needs, whereas our design focus is always member-centric.

Next Steps

Pension investing is changing fast. Many trustees face difficult choices as they decide to delegate in the face of regulatory pressures. To avoid the pitfalls, we believe trustees need to focus on the essential dos and don’ts: looking to the future not the past; choosing providers with a clear history and strong track record in continuous improvement; and insisting on strong data and clear transparency into performance, cost and risk. The TDF structure makes investing simpler and clearer for trustees and members. It also enables continuous and seamless enhancements. Before making their choice, trustees should look to their prospective TDF managers’ track records for evidence of what they do and don’t.

For further information please contact:

Michelle Inskip
Managing Director—UK Institutional Client Group
T: 020 7959 4784 M: 07887 765 729
michelle.inskip@alliancebernstein.com

Stephen Wells
Managing Director–Consultant Relations
T: 0207 959 4783 M: 07342 990 288
stephen.wells@alliancebernstein.com

Kirsty Beasley
Director–Consultant Relations
T: 0207 959 4948 M: 07467 705 048
kirsty.beasley@alliancebernstein.com

Past performance, historical and current analyses, and expectations do not guarantee future results. There can be no assurance that any investment objectives will be achieved. The information contained here reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed here may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AB or its affiliates.

The views expressed herein do not constitute research, investment advice, or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.

About the Authors

Henry Smith is a Vice President and Investment Strategist on AB’s Multi-Asset Solutions team. He is responsible for the product strategy and communication of AB’s UK defined contribution, custom multi-asset and sustainable multi-asset solutions. Smith joined the firm in 2019, following more than two years at Lane Clark & Peacock, where he provided investment, research and governance advice to a range of UK defined contribution pension schemes. Before that, he worked at Capita Employee Solutions, where he advised both UK defined contribution and defined benefit pension schemes. Smith holds a BSc in financial economics from the University of Essex and is a CFA charterholder. Location: London

David Hutchins is a Senior Vice President and Head of AB's Multi-Asset Solutions business in EMEA. He is responsible for the development and management of multi-asset portfolios for a range of clients. Hutchins joined the firm in 2008 after spending two years at UBS Investment Bank, where he was responsible for devising and delivering innovative capital markets risk-management solutions for pension schemes. Prior to that, he spent 13 years at Mercer, where he served as a European principal and scheme actuary, providing trustee and corporate advice to a range of UK pension funds and their sponsors. Hutchins holds a BSc in mathematics and a PGCE from the University of Bristol. He has chaired the Investment Management Association's Defined Contribution Committee and formerly chaired the defined contribution industry working group for the UK government's "defined ambition" project. Hutchins is a Fellow of the Institute and Faculty of Actuaries. Location: London

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