August 2016
Target date funds:
Why the “to vs. through” analysis
falls short and what you should
be considering
Executive Summary
Target date funds (TDFs) are a substantial and growing segment within
the QDIA space, representing professionally managed, single-vehicle
investment solutions. However, not all TDFs employ the same investment
philosophy, and there are important distinctions between TDFs to consider.
Jake Gilliam
Senior Multi-Asset Class
Portfolio Strategist
Primarily responsible for
contributing to strategic decisions
for all multi-asset class portfolios
as well as several single asset-class
portfolios within CSIM and Schwab
Bank Collective Trust Funds.
Mr. Gilliam also represents CSIM’s
multi-asset class strategies to the
institutional marketplace, clients,
and the media.
To date, much time and energy comparing TDFs has been spent on
whether the equity landing point occurs at the retirement year, or
beyond. However, we believe that instead of such an approach,
plan sponsors should critically examine how fund architecture, risk
management, and the evolution of investment mix throughout a fund’s
glide path can complement one another to address the needs and
demographics of plan participants. This paper offers actionable
guidance that plan sponsors can employ to help evaluate whether
a TDF appropriately balances its potential for growth while reducing
the level of risk as an investor approaches retirement, and beyond.
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Kevin Bowman
Managing Director,
Asset Allocation Products
Primarily responsible for the
product management of Schwab’s
Target Date, Target Risk, Balanced,
Managed Payout, and other
products for the institutional
retirement marketplace.
Key takeaways
• While the question of whether or not a TDF’s glide
path extends “to” or “through” a given point in time
is important to understand, we believe that plan
sponsors should look beyond this comparison.
• Contrary to common belief, TDFs with “to” glide
paths are not always more conservative than those
with “through” paths; in fact, a “through” fund may
potentially provide better downside protection while
benefitting investors well past its target date.
• Within a fund’s glide path, plan sponsors should
consider the asset allocation, architecture type, and
methods for managing absolute risk.
• Asking the right questions helps plan sponsors
to select a TDF series that will meet the needs of
their participants.
Target date funds: Why the “to vs. through” analysis falls short and what you should be considering | 2
Introduction
Targe date funds have become a large and important part of employer-sponsored
retirement plans like 401(k)s, largely in response to The Pension Protection Act of 2006,
which allows employers to enroll employees automatically in workplace retirement plans.
The law permits plan sponsors to invest workers’ contributions in “default” investments,
called “qualified default investment alternatives” (QDIAs), which must be appropriate
and capable of meeting a worker’s long-term retirement savings needs. TDFs, which are
professionally managed and automatically rebalance to become more conservative as
an employee gets closer to retirement, have become the most popular QDIA choice for
plan sponsors.
However, the TDF marketplace is large and growing—comprising more than 50 mutual fund series in
20151—making it increasingly difficult for plan sponsors to identify a TDF series that offers the best mix
of investment characteristics for their plan participants. Part of this difficulty stems from the prevalence
of what we believe to be a shortsighted method for evaluating TDFs: that is, whether funds designed to
get investors “to” a targeted point in time, or those engineered to continue shifting their allocations past
or “through” this point in time, are more appropriate for retirement-focused savers such as 401(k)
plan participants.
TDFs have evolved significantly in recent years, with various nuances and construction differences. As
a result, the traditional “to vs. through” analysis is proving too rudimentary: it oversimplifies what is an
incredibly important fiduciary decision. In our view, a plan sponsor’s due diligence of TDFs should instead
revolve around a number of more sophisticated criteria that, when looked at comprehensively, better
determine a fund family’s viability as a prudent long-term solution for plan participants and sponsors alike.
We believe more detailed aspects of asset allocation, diversification, fund selection, and evolution of
investment mix over time are all critical differentiators in determining the suitability of a TDF series, beyond
just analyzing the landing point of stocks and bonds. This paper explores these factors and provides
actionable guidance that plan sponsors can use to evaluate the appropriateness of a TDF series for their
plan and its participants.
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Investment Company Fact Book, 2015, p. 230.
Target date funds: Why the “to vs. through” analysis falls short and what you should be considering | 3
Why “to vs. through” is not enough
1. Asset allocation
Many industry pundits and the media tend to
focus their attention to TDFs on whether a “to”
or “through” approach is most effective. In “to”
funds, equity exposures typically slide downward
and reach their lowest level on the target date.
By contrast, “through” funds do not reach their
lowest equity concentrations on a specific date,
but rather continue to decrease exposure
through the target date and into retirement.
One of the chief factors plan sponsors should
consider when determining the relative merits of
a TDF family is its asset allocation approach—that
is, how much exposure the funds have to certain
asset classes. Asset allocation is important because
it signifies how the funds aim to balance risk and
reward potential in the portfolio. In general, the more
diverse the underlying asset allocation, the less
volatile the funds tend to be.
“Through” funds are often perceived as inherently
riskier than “to” funds. Contrary to this popular
belief, however, “to” funds are not necessarily more
conservative, and “through” funds can potentially
provide better downside protection while benefitting
investors well past a fund’s target date—particularly
if the fund is thoughtfully designed. Rather than
remain mired in the “to” or “through” debate, plan
sponsors should instead evaluate a TDF family by
looking at three important features:
It used to be that a simple mix of stocks, bonds,
and cash was believed to provide adequate
diversification. Increasingly, however, TDF managers
are broadening their approach to asset allocation.
Why? Because stocks and bonds are not homogenous
categories—there are sub-asset classes and sectors
within each category that carry their own risk profiles
and return expectations. Therefore, two TDFs that
have seemingly similar allocations to stocks, bonds
and cash at their target dates—say 40%/55%/5%—
could expose participants to very different levels
of risk.
1. Asset allocation
2. Underlying fund architecture
3. Risk
These features, when considered alongside plan
sponsor goals and investor demographics such as
age, salary, contribution rates, likely risk tolerance,
average level of assets, and behavior at retirement,
should help plan sponsors understand whether
a TDF family meets participant needs and
fiduciary requirements, particularly in relation to
QDIA compliance. We believe these underlying
considerations to be far more revealing about the
suitability of a TDF family than the simple “to vs.
through” approach.
One of the chief factors plan
sponsors should consider
when determining the relative
merits of a TDF family is its
asset allocation approach.
Take stocks, for instance. Asset allocation is no
longer about placing 40% (or 30% or 50%) of a
portfolio in equities. This is because the stock
category itself is huge, composed of many layers
of sub-asset classes. For example, you could divide
stocks into domestic and international sub-asset
classes, and then divide each of those into small-,
medium- and large-cap asset classes, as well as
by growth or value characteristics, and even by
sectors and industries. You could also break down
the international stocks by type of economy, such
as developed, emerging, or frontier markets. There
also are stock-like securities—such as real estate
investment trusts, master limited partnerships and
preferred stocks—to consider. And each class of
stock has markedly different risk and reward profiles
than the others.
The fixed income market is similarly diverse. Treasuryissued securities have unique traits compared to
high-yield bonds and mortgage-backed securities.
Target date funds: Why the “to vs. through” analysis falls short and what you should be considering | 4
Government-issued debt in emerging markets has
a very different risk/reward profile than high-grade
corporate bonds in developed nations. Duration
opens another dimension in bond portfolio variety:
a portfolio skewed to long-term bonds might be more
vulnerable to volatility than a short-term-dominated
portfolio, especially in an environment where interest
rates are rising, or poised to rise.
In short, wide differences exist in how TDF managers
approach asset allocation and diversification—and
these differences in investment philosophy and
practice can, especially over time, have a marked
impact on a fund’s performance, regardless of
whether it employs a “to” or “through” approach.
It is not enough to ensure that
a fund family is adequately
diversified—plan sponsors also need
to ensure that the funds employ a
sophisticated approach to adjusting
asset allocations over time.
It is not enough to ensure that a fund family is
adequately diversified—plan sponsors also need
to ensure that the funds employ a sophisticated
approach to adjusting asset allocations over time,
so that risk exposure is reduced as a participant
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Takeaway
When evaluating TDF families, plan sponsors
should look for funds with a sophisticated mix
of assets that provide diversified exposure to
a broad swath of the investable world. Plan
sponsors should also ensure that the TDFs are
adjusting their asset allocations over time in
order to reduce risk as participants age.
ages. Exposure to riskier sub-asset classes, such
as emerging market stocks and high-yield bonds,
might be reduced or eliminated entirely, while
exposure to more conservative sub-asset classes,
such as domestic large caps and U.S. Treasuries,
might increase. Thus, the funds’ asset allocation
and diversification should evolve to reflect
the changing needs of your plan’s participants.
(For more on this topic, see “3. Risk” on page 6.)
2. Underlying fund architecture
Plan sponsors should also investigate how a fund is
architected—that is, what kinds of underlying funds it
holds—and how that could impact fund performance
over time. TDFs that invest only in proprietary active
strategies—those operated by the firm offering the
TDF—have what is known as “closed architecture.”
Other TDFs deploy “open architecture,” which means
they may include funds or strategies managed by
other firms exclusively, or alongside their own
proprietary funds.
As part of their due diligence, plan sponsors
seeking a TDF with “active management” exposure
(using strategies that attempt to add value relative
to an index or benchmark) should understand
the key differences between proprietary-only and
open-architecture TDFs. We believe openarchitecture TDFs offer four benefits that make them
attractive to many plan sponsors: diversification,
cost, track record and flexibility.
• Diversification: Active open-architecture
TDFs often offer a diverse mix of investing styles
because managers can seek out leading active
managers who provide a broad range of
research, processes and schools of thought
about the markets. Conversely, closedarchitecture TDFs leverage only the research,
analysts and economic outlook provided by
their proprietary managers.
Target date funds: Why the “to vs. through” analysis falls short and what you should be considering | 5
• Cost: Because of their flexible nature, openarchitecture funds might be able to negotiate
on price in a competitive search process.
These lower costs often translate into savings
for plan sponsors and participants.
• Track record and flexibility: When selecting
active strategies, open-architecture TDFs can
define the criteria for the type of exposure they
want, and therefore seek out managers and funds
with demonstrated expertise. Conversely, closedarchitecture TDFs are limited to offering what’s
on their shelf, so while they may be able to offer a
product to fill a particular slot, it can be harder for
them to demonstrate their process for selecting
the best strategies for plan participants. And, with
a wider universe of available strategies, portfolio
managers can benefit from a greater ability to
make changes or additions to the underlying funds.
Having a wide array of fund choices enables TDF
managers to cultivate a diversity of thought on top
of diversified asset allocations. Unlike funds that
are limited to using only proprietary active products,
open-architecture TDFs can select from an
unconstrained universe of strategies, and make
adjustments as warranted. This helps mitigate the
potential for conflicts of interest and provides better
diversification, which should lead to a smoother
ride for plan sponsors and participants alike.
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A common misconception
about “to” funds is that, because
they tend to have less exposure
to stocks at their target dates,
they are inherently less risky.
3. Risk
A common misconception about “to” funds is
that, because they tend to have less exposure to
stocks at their target dates, they are inherently
less risky. The problem with this belief is that it
does not account for absolute level of risk over
the course of the TDF’s glide path. We believe it is
more useful to understand how—or if—a fund’s
absolute level of risk decreases as participants
move through retirement.
Plan participants’ age and risk tolerance, as well
as market conditions, may combine to argue for
higher or lower equity allocations throughout
retirement. A “to” fund with 40% exposure to equities
at its target date—which may seem like a reasonable
exposure at retirement—may prove to be a relatively
high allocation if it is held constant and held by
retirees late into their lives, when a 40% allocation
for someone in their 80’s may no longer seem as
prudent. Other TDFs might take a different approach,
reducing equity exposure throughout retirement in
order to reduce risk while still maintaining some
growth potential for retirees.
Takeaway
When evaluating TDFs with active management
exposures, it is important to remember that any
one firm is unlikely to offer the best strategies
with demonstrated track records in every asset
category. We believe that those TDFs with the
freedom to bring top active funds or sub-advisers
together under one umbrella, regardless of
the firm with which they are associated, are
worth considering for plan sponsors and plan
participants alike.
Target date funds: Why the “to vs. through” analysis falls short and what you should be considering | 6
Glide path variables
An effectively developed glide path should grow more conservative as retirement approaches, adjusting its asset classes,
asset allocations and management styles to ensure proper alignment for plan participants.
As Retirement Approaches
Equity
Portfolio
Fixed Income/
Cash Equivalents
Portfolio
LESS...
MORE...
Active Management
Passive Management
Domestic Small Cap
Domestic Large Cap
International
Domestic
Emerging Markets
International (Developed)
Active Management
Passive Management
Credit Risk
Inflation-Protected Bonds (U.S. TIPS)
Duration
Short-Term Bonds & Cash Equivalents
International
Domestic
For illustrative purposes only.
Glide paths should take into
account multiple variables,
including participant behavior
and tolerance to volatility.
Glide paths should take into account multiple
variables, including participant behavior and
tolerance to volatility. As the fund’s target date
approaches, its glide path should begin to shift
focus away from wealth accumulation and toward
downside protection. Upon reaching the target
date, the emphasis should then shift to capital
preservation in order to help ensure the plan
participants’ funds last as long as possible.
This is not to say allocations should become less
diversified in retirement. On the contrary, we believe
that diversified exposure in retirement is essential,
especially as people continue to live longer and
more productive lives. Maintaining adequate
diversification helps mitigate risk, which in turn helps
ensure that plan participants’ needs will continue
to be met throughout retirement without depleting
their account balances too quickly.
As with asset allocation, a glide
path is far more than a number—
it is a weighting of assets
distributed within a portfolio.
As with asset allocation, a glide path is far more
than a number—it is a weighting of assets distributed
within a portfolio. Practically speaking, there is near
unanimity about lowering equity exposure over the
course of a glide path. But the details of how this
Target date funds: Why the “to vs. through” analysis falls short and what you should be considering | 7
Sample “to” approach: A static investment philosophy
The asset allocation of a “to” approach remains static after the TDF reaches its target date, with limited ability to adjust
as an investor’s needs and risk tolerance continue to become more conservative.
100%
Cash
90%
Fixed Income
80%
70%
Equities
Continuous Allocation
25% Equities
65% Fixed Income
10% Cash
60%
50%
Starting Allocation
95% Equities
5% Fixed Income
0% Cash
40%
30%
Target Date
25% Equities
65% Fixed Income
10% Cash
20%
10%
0%
45
40
35
30
25
20
15
Years Before Target Date
10
5
0
Target
Date
+5
+10
+15
+20
+25
Years After Target Date
Large Cap
(Domestic)
Mid-Cap
(Domestic)
Small Cap
(Domestic)
International
Equity
Diversified
Emerging Markets
Global Real
Estate
Commodities
Broad Basket
World
Bond
IntermediateTerm Bond
Short-Term
Bond
Cash
Equivalents
InflationProtected Bond
The target date is the date when investors are expected to begin gradual withdrawal of fund assets. For iIllustrative purposes only.
is accomplished are critical. As the glide path
progresses, we believe TDFs should reduce holdings
to asset classes and management styles that tend
to carry greater risk, such as funds that are actively
managed or those that focus on assets with higher
volatility and potential for large capital losses, such
as domestic small caps and emerging markets.
As an example, consider a “to” fund that culminates
in a 35% equities holding when an investor reaches
age 65. That same portfolio would hold a little more
than a third of its assets in equities when the investor
celebrates turning 75, 90 or even 100. While that
allocation might prove successful, its rigid adherence
to the 35% stock stake does not appear to take
into account the investor’s changing needs and risk
tolerance during an investor’s later years.
Target date funds: Why the “to vs. through” analysis falls short and what you should be considering | 8
Sample “through” approach: An evolutionary investment philosophy
The asset allocation of a “through” approach continues to adjust even after a TDF reaches its target date, shifting its
asset mix to suit the needs of plan participants who are enjoying their golden years.
100%
Cash
90%
Fixed Income
80%
70%
Equities
Final Allocation
25% Equities
66% Fixed Income
9% Cash
60%
50%
Starting Allocation
95% Equities
5% Fixed Income
0% Cash
40%
30%
Target Date
40% Equities
53% Fixed Income
7% Cash
20%
10%
0%
45
40
35
30
25
20
15
Years Before Target Date
10
5
0
Target
Date
+5
+10
+15
+20
+25
Years After Target Date
Large Cap
(Domestic)
Mid-Cap
(Domestic)
Small Cap
(Domestic)
International
Equity
Diversified
Emerging Markets
Global Real
Estate
Commodities
Broad Basket
World
Bond
IntermediateTerm Bond
Short-Term
Bond
Cash
Equivalents
InflationProtected Bond
For iIllustrative purposes only.
In contrast, a “through” fund might land at 40%
equities when the investor hits age 65—and then
gradually decline to 25% by age 85, focusing mainly
on large-cap domestic stocks, reducing the portfolio’s
risk to market volatility and accounting for investors’
changing needs as they live through retirement.
Similarly, it is important to consider how a fund’s
glide path increases exposure to fixed income over
time. Plan sponsors should consider how a TDF
manager balances perceived benefits of fixed income
(such as stability and income preservation) with
the potential drawbacks (such as interest-rate and
credit risk). For example, as the fund progresses
beyond its target date, a manager might choose to
place more prominence on investments that offer
stability and combat risk, such as short-term bonds,
cash equivalents, and TIPS, and reduce exposure
to investments that carry too much credit or interestrate risk.
In the end, balance should be a central consideration:
plan sponsors should evaluate how a fund manager
is maintaining adequate growth potential while
reducing the TDFs’ overall level of risk.
Target date funds: Why the “to vs. through” analysis falls short and what you should be considering | 9
Conclusion
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Takeaway
When evaluating TDFs, it is important to look
inside the glide path and fully understand how a
TDF manager approaches glide path allocations
over time. Some holdings within stocks and
bonds are inherently riskier than others, so
paying attention to the high-level breakdown of
stock, bond and cash allocations isn’t enough.
Plan sponsors should consider absolute risk—
how the fund manager is balancing asset
longevity with market- and investment-specific
risk—when selecting TDFs for their plans.
More and more employee-sponsored retirement
plans are turning to TDFs, automatically enrolling
participants to help ensure they will have enough
savings to fund their retirement. TDFs have a lot
going for them: they are low maintenance, provide
diversification, rebalance holdings automatically,
and shift to a more conservative allocation over
time. There are now more than 501 TDF mutual
fund series—and they represent a wide range of
approaches and strategies. Therefore, it is critical
for plan sponsors to choose the best TDF solution
for their employee base and ensure that the funds
they offer are structured, built and managed in
ways that comply with QDIA requirements and
meet the expectations of their plan participants.
Instead of focusing on a simplistic “to vs. through”
approach for evaluating a TDF series, we believe
plan sponsors need to focus on how three critical
differentiators—asset allocation, fund architecture
and risk management—complement the needs and
demographics of their plan participants. By focusing
on these three factors, we believe plan sponsors
will be better equipped to find a TDF family that will
help plan participants achieve their long-term savings
goals and enjoy a financially healthy retirement.
Investment Company Fact Book, 2015, p 230.
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Target date funds: Why the “to vs. through” analysis falls short and what you should be considering | 10
Charles Schwab Investment Management
As one of the nation’s largest asset managers, our goal is to provide investors
with a diverse selection of foundational products that aim to deliver consistent
performance at a competitive cost.
Target date fund asset allocations are subject to change over time. The principal value of the funds
is not guaranteed at any time, and will continue to fluctuate up to and after the target date. There is
no guarantee the funds will provide adequate income at or through retirement. The funds are built for
investors who expect to start gradual withdrawals of fund assets on the target date, to begin covering
expenses in retirement.
Target date fund asset allocations are subject to change over time in accordance with each fund’s prospectus. The funds are subject
to market volatility and risks associated with the underlying investments. Risks may include exposure to international and emerging
markets, small company and sector equity securities, and fixed income securities subject to changes in inflation, market valuations,
liquidity, prepayments, and early redemption.
Diversification strategies do not ensure a profit and do not protect against losses in declining markets.
This information is being furnished as educational and is not intended to constitute investment advice. Readers are expected to
consult with their legal or financial advisors as applicable.
The material in this presentation is based on information from a variety of sources we consider reliable, but we do not represent that
the information is accurate or complete. Errors and omissions can occur. None of the information constitutes a recommendation by
Charles Schwab Investment Management or a solicitation of an offer to buy or sell any securities.
©2016 Charles Schwab Investment Management, Inc. All rights reserved. IAN (0516-G5H0) MKT92829-00 (08/16)
00170748
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