As we march along into 2020, we’ll start reviewing what occurred in the TDF market in the last quarter on 2019. The first aspect we’ll look at is returns.
By Clayton Fresk on February 26, 2020
As we march along into 2020, we’ll start reviewing what occurred in the Target Date Fund (TDF) market in the last quarter on 2019. The first aspect we’ll look at is returns.
Overall for the quarter, TDFs experienced strong, but relatively widely varied, returns. Here is a snapshot of returns, with the TDF vintages along the X axis:
Chart Source: Stadion
For longer term investors (we’ll call it 2060 through 2040 vintages), returns were strong, with the S&P Target Date Index (the black line on the chart) returning between 7.2-7.8%. However, the range of returns were also relatively wide, with returns from 9.5-10% for the strongest performers down to about 4-4.5% for the weaker, so roughly a 5.5% return range. That 5.5% range pretty much held true as the vintages neared retirement.
However, that range in and of itself is not necessarily abnormal or even a problem per se. As we’ve talked about in previous posts, there is a wide spectrum of equity exposures in the TDFs at each vintage, so having a wide spectrum of returns naturally makes sense – especially in periods where there is a large divergence in equity and fixed income returns (which we’ll touch on in a bit).
What one can examine by digging a bit deeper is to look at the relationship between returns and the underlying equity exposure. The chart below is an example of the 2030 vintage, with returns on the y axis and the respective equity exposure on the x-axis.
Chart Source: Stadion
You can see there is a linear relationship between the amount of equity and the return. However, you can also see anomalies to the relationship. For example, if you look at the approx. 64% equity exposure, there is a wide range of returns for the TDFs with said exposure, ranging from ~7.5% on the top to ~3.2% on the bottom.
We can then dig into what would cause this type of discrepancy. Given both these TDF have almost identical equity exposure, we then need to dig into what type of equity exposure (and fixed income exposure) they have.
Some common discrepancies in exposure we see are:
- U.S. vs INTL equity exposure – many periods this can be a main driver of dispersion. However, for 4Q19, both these exposures had similar returns at about 9% (measured by MSCI US and MSCI ACWI Ex-US)
- Market Cap (Large vs Mid vs Small cap) – this can also drive dispersion if we see part of the market cap structure strongly out/underperform This quarter saw some dispersion but nothing drastic (9% for large, 7% for mid, and 8.2% for small as measured by respective S&P indices)
- Developed vs Emerging: we started to see dispersion here which would benefit TDFs more highly weighted towards Emerging Markets, with EM returning nearly 12% on the quarter vs 8% for developed markets (as measured by MSCI)
- Growth vs Value: after seeing some rather publicized value underperformance for a longer time period, we saw this relationship reverse a bit in 4Q19 as value returned nearly 10% vs 8.3% for growth (as measured by the respective S&P 500 index)
- Active vs Passive vs Alt-weighted (Smart Beta) – While a little harder to quantify without a deeper dive into the active vs passive exposure, we can see dispersion some of the alternative-weighting schemes. For example, on the factor front we saw a rather large underperformance in Low/Min Volatility, and to a lesser degree the Momentum factor.
- Fixed Income: While the absolute effect of fixed income differentials is smaller, they can still drive performance. This quarter we say high yield strongly outperform the aggregate (which makes sense in a strong equity rally). We also saw the treasury curve normalize, where the previously fretted yield curve inversion disappeared, and we saw the long end of the curve climb nearly 30bp (to the detriment of those with longer-duration holdings).
So, where does that leave us heading into 2020? Like we’ve mentioned before, looking at only one quarter’s worth of returns when analyzing a particular TDF does not give a broad enough picture. However, analyzing these returns to see why they may be different than another TDF can be very important.
Author: Clayton FreskClayton Fresk joined Stadion Money Management in 2009 and currently serves as Portfolio Manager of Stadion’s Retirement investment strategies, which comprises oversight of Stadion’s managed account, target-date, and risk-based strategies. He provides thought leadership for Stadion’s participant level, customized retirement solutions, in order to ensure that its glide path technology and asset allocation are able to support all intermediaries in the defined contribution ecosystem. Clayton holds the Chartered Financial Analyst designation and is a member of the CFA Institute and the CFA Society of Minnesota. He also received an MBA degree and a Bachelor's degree in Finance & Marketing from the University of Minnesota.
There is no guarantee of the future performance of any Stadion account. Material has been derived from sources considered to be reliable, but the accuracy and completeness cannot be guaranteed. Results based on available universe of Target Date Fund Series, which includes registered mutual funds, and non-registered collective investment funds and insurance accounts. Collective investment funds and insurance accounts are only available for investment to qualified retirement plan assets such as 401(k) plans.
The commentary, analysis and opinions expressed are those of Stadion’s Investment Team. The commentary, analysis and opinions referenced are as of the date of publication and are subject to change without notice. This material is for informational purposes only and should not be considered investment advice. This is not a recommendation to buy or sell a particular security. The investment strategy or strategies discussed may not be suitable for all investors. Investors must make their own decisions based on their specific investment objectives and financial circumstances.
Indices presented have a volatility that is materially different from that of the Target Date Funds shown. Index returns do not include transaction fees, management fees or any other costs. It is not possible to invest directly in an index.
Stadion Money Management, LLC (“Stadion”) is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about Stadion’s investment advisory services can be found in its Form ADV Part 2, which is available upon request.
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