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Getting Beyond Labels in the "To vs. Through" Debate

Whether it’s “to” or “through” retirement, there’s plenty of room for improvement in explaining the goals of target-date funds. 

Josh Charlson, 10/10/2011

One of the catch phrases of the target-date industry is “to” versus “through.” The idea is that some target-date series are built to manage the investors’ asset allocation to the time of retirement, represented by the date on the fund (such as 2010 or 2015), while other series are constructed to take the investor through retirement. Earlier in 2011, the issue of whether target-date funds should go “to” or “through” retirement was revived in a report released by the U.S. Government Accountability Office at the request of U.S. Sen. Herb Kohl’s Special Committee on Aging. In that report, the GAO suggests that the Department of Labor require plan sponsors to consider the suitability of a target-date series’ asset allocation when choosing a provider because of the great variability among the asset-allocation glide paths.

The “to” versus “through” proposition sounds like an elegant division but is muddled in practice. Funds with unchanging glide paths after their target dates are said to be “to” because the target-date fund provider is not attempting to model investors’ risk/return needs during the retirement period, and therefore, the series’ asset allocation or glide path should not change. In contrast, those with glide paths that continue to change after their retirement date are said to be “through.” Those fund series are modeling investors’ needs during the years following retirement. Lacking clear statements from the target-date families as to whether their funds are intended as “to” or “through,” plan sponsors or investors using target-date funds are forced to use their own judgments to determine which is which. Moreover, that basic distinction can have a big impact on how an investor or advisor might incorporate a target-date fund into a broader portfolio at or during retirement.

To shed light on the debate, Morningstar took a closer look at how the industry’s glide paths are actually constructed, using the glide-path data available in fund prospectuses. The “to” group comprises those target-date series whose glide paths do not change after the retirement date, and the “through” group comprises those series whose glide paths continue to change following the retirement date. In some cases, the analysis required a degree of interpretation by Morningstar data and mutual fund analysts because of the challenges discussed above. While certain broad generalizations do differentiate the two groups, Morningstar found there is also a great deal of variability within each group, and more than a few cases are difficult to place altogether.

No Consensus
We found no asset-allocation consensus in the industry regarding the prevalence, superiority, or clear categorization of “to” or “through” glide paths. Of the 41 glide paths Morningstar examined, 23 fell into the “through” group, with the remaining 18 landing in the “to” camp. Even though the “through” glide paths are in the majority and even though several firms, such as John Hancock and Vantagepoint, have extended the phase during which they reduce the funds’ equity exposure, there’s no evidence that such glide paths have a lock hold on the industry’s thinking.

The “to” and “through” samples look very similar in their asset allocation when investors are in their early earning years. For target dates 2055 through 2040 (intended for investors ages 20 to 35), the average equity allocations are nearly identical, roughly around 90%.

It’s when investors get closer to retirement that the differences start to show up, as “to” series typically move more rapidly toward the lower final equity point. The 2020 funds show 14-percentage-point difference in equity allocation, for example, and that difference grows to 16 points by the retirement date. At retirement, the “through” funds average a 49% stock allocation while “to” funds land at 33%. It’s not until 10 years later that the glide paths meet up again, as “through” glide paths hit an average allocation of 33%. Some “through” funds reduce their exposure to stocks over an additional five to 15 years.

So, it’s in that 20-year band around the retirement date that the differences are most stark. Clearly, “through” glide paths on average carry higher equity risk, fitting the belie that the risk of retirees outliving their nest egg requires more stock investments, over longer periods, in order to raise the probability of those assets lasting through retirement. “To” paths, as advertised, cut down equity to a more manageable level by retirement, reducing the risk that investors’ assets will experience a catastrophic decline just prior to their time of need.

Devilish Details
Yet those averages mask a wide range of risk/reward profiles within each group. Fo example, the equity allocations for “to” funds ranged from 24% to 50% and from 25% to 67% for the “through” funds. The time period that each series takes to arrive at a final asset allocation after the retirement date also ranges widely, from roughly five to 30-plus years. These ranges suggest significant philosophical differences even within a given grouping. AllianceBernstein’s and Goldman Sachs’ target-date series, with stock targets in the high 60s for 2010 funds, clearly have more-aggressive assumptions than, say, Schwab’s, which devotes only 40% of assets to stocks at the same stage.

The asset mix of the funds also varies from series to series. Some series, including Vanguard’s, emphasize investment-grade and inflation-protected bonds after th retirement date as a protective measure, while others such as Fidelity and John Hancock provide greater exposure to high-yield bonds as a means of increasing the funds’ income stream. Providers such as T. Rowe Price and JP Morgan have built-in exposure to additional asset classes including commodities or real estate in recent years, citing their inflationfighting and/or diversification potential.

The difficulties of inferring a philosophy base on the publicly disclosed glide-path allocations emerge in other aspects of our list. One example is the Wells Fargo DJ Advantage series, which shows up in the “through” sample despite a 25% allocation to stocks for its 2010 fund. Wells Fargo has one of the industry’s most-conservative target-date philosophies, so why did it end up in the “through” group, which is conventionally viewed as being more aggressive? Because its stated glide path extends beyond retirement, dropping equities to an extremely low 15% fiv years later. On the other side of the coin, the BlackRock Lifecycle Prepared series lands in the “to” camp in the analysis above, even though its 50% allocation to equities is more consistent with the “through” group. That’s because its allocation does not change after the retirement date.

Our analysis revealed a number of other cases where series’ asset allocations were either more aggressive or more conservative than their “to” or “through” peer groups would suggest. Further complicating the issue, recent research by Ibbotson Associates shows that changes to the series’ strategic asset allocation are more common than one might expect. What our colleagues refer to as “glide-path instability” means that the glide path an investor chooses today may look quite different 10 or 20 years down the road. These observations debunk the assumption that investors can determine whether a series is in the “to” or “through” camp solely by the trajectory of its glide path.

Finally, there’s also no consensus around the terminal investment for the series. Morningstar discerned no pattern as to whether a series used a retirement-income fund or not. One might imagine that “to” paths don’t require a retirement-income fund because the glide path is not supposed to shift. However, 13 of the 18 glide paths do. And seven of the 23 “through” glide paths lacked a retirement-income fund. John Hancock, for example, extended its glide path and chose to manage the asset allocation of the terminal fund, rather than maintaining a separate income fund. In some cases, the glide-path illustration as detailed in a series’ fund prospectus did not accurately describe further changes within the series’ retirement-income fund.

Implications for Investors
In light of the complexity mentioned above, investors, advisors, and plan sponsors are forced to use their own judgments to determine whether a particular series is suitable or appropriate given an investor’s individual needs. The ”to” versus “through” distinction is critical because the design of the glide path has a material impact on the potential risks of a target-date fund and should help determine whether a target-date fund remains appropriate for an investor who is entering or well into retirement.

For example, plan participants or investors requiring additional capital appreciation in retirement would be ill-served by solely holding a fund that has shifted to a fixed-income heavy allocation by retirement. Conversely, investors focused on capital preservation may not want to shoulder the substantial equity risk that comes with some of the funds.

A further challenge for advisors is considering how to complement a target-date fund held in a client’s retirement account with the holdings in the rest of the portfolio. Beyond determining the target-date fund’s orientation toward capital appreciation or capital preservation and its fit with the clients goals, advisors may also need to investigate the target-date offering’s focus on producing an income stream, which varies widely between providers.

Morningstar does not take a position on the superiority of a “to” or “through” glide path. The main point is that both types can serve as portfolio anchors, but it’s much less likely that any single fund will meet all of an investor’s retirement needs.

While we are agnostic regarding which specifi asset allocation is best, we emphatically favor those target-date series whose managers have proven expertise across all the asset classes represented in the portfolio, including series offered by T. Rowe Price, JP Morgan, and American Funds. We also home in on those with low expenses, such as those offered by Vanguard and TIAA-CREF, because lower fees leave more capital to compound over the decades that investors, including retirees, are likely to hold a target-date fund.

At the industry level, the “to” versus “through” debate is likely to continue, as attitudes toward asset allocation and investors’ retirement needs continue to evolve. In the meantime, we believe target-date fund providers have plenty of room for improvement when it comes to describing the rationale and construction of their target-date funds, whether they should be viewed as “to” or “through” offerings, and what the potential risks of either approach could be. That clarity, combined with investors’ own careful consideration of where a target-date fund might fit within a broade portfolio, would help ensure they use target-date funds effectively, regardless of their glide path.

Josh Charlson is a senior fund analyst with Morningstar.
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