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Posted by on Sep 16, 2015 in ETF Strategist, Market Insight

Learning From Target Date Funds Without Actually Using Them

Learning From Target Date Funds Without Actually Using Them

By Roger Nusbaum, AdvisorShares ETF Strategist

The Wall Street Journal recently wrote about the extent to which Target Date funds are starting to incorporate liquid alternatives “in hopes of steadying performance with assets that may not move in lock step with mainstream stocks and bonds.”

For anyone who doesn’t know, Target Date funds are designed to offer a core solution that adjusts asset allocation in line with its target date. A 2016 target date fund would likely have very little in equities because the assumption is that the person buying it would be retiring in 2016 where a 2045 target date fund would likely have a heavy exposure to equities on the assumption that the person buying it would be retiring in 2045.

I believe that target fund managers allocating to alternatives at the expense of fixed income, keep in mind the percentages are small, is very interesting as well as telling about their expectations for traditional fixed income in the years to come.

Yields generally fell for more than 30 years which is something that can’t be repeated from here. It would seem like rates have to go up from here even if we aren’t sure when that actually starts but even if that doesn’t happen, if rates churn around in the same narrow range that they have been for the last year or so then the dilemma of low yields still exists and the threat of higher yields would also still exist.

This is part of the logic underlying my long held belief for having a small allocation to alternatives (in years past I referred to them as diversifiers).

The fund marketplace, as we’ve talked about before, is offering more alternatives, some of which will work well and some probably will not. Additionally there are now more unconstrained bond funds coming to market that also try to address this issue.

While I am on board with the idea of modest use of alternatives I have never been a fan of target date funds. Each provider tend to have different ideas about how to move along the glide path from more equities to more fixed income and those differences led to a lot of surprises during the great recession and it is a good bet there will be a lot of surprises whenever the next bear market comes along.

Target funds delegate too much in my opinion. My starting point is to believe in active management even if that means using passive products in an active fashion and the idea of a glide path that could be based solely on 20 years to retirement, ok now it’s 19 years seems intuitively like a bad idea and again led to a lot of negative surprises in the last bear market.

But the conclusion about fixed income and wanting to supplement it somehow is worth listening to as we are seeing more of it, CALsters recently made an announcement to the effect.

The takeaway is something that we have been talking about for a long time which is that fixed income investing has become more difficult as yields have become so low and it is likely to remain difficult whenever they start to go back up.

One unrelated item from a recent article about retiring overseas at MarketWatch from the reader comments; amidst all of the comments of why no one will ever retire again and the blame pointed at both political parties was one anecdotal observation that people who manage to retire the way they want tend to be out of debt by the time they are 40 and then accumulate wealth between the ages of 40 and 60. This struck me as being very insightful with a big component to this path to success being living below your means.