Capital Ideas^™ 
Investment insights from Capital Group

When it comes to target date funds, cost matters. But since participants could be invested in these funds for decades, every potential advantage should be considered. For a fully active solution, there are three potential sources of excess return to consider, as actively managed target date funds seek to deliver value in three ways.

The first is through the choice of a strategic glide path, the long-term targeted allocations to various asset classes (primarily equity versus fixed income). The second is through tactical allocations, purposeful shifts from those asset allocations in response to market conditions. The third way — a critical differentiator — is through security selection, the potential to generate excess returns via active management decisions.

But passive target date solutions¹ — which constitute the majority of the nearly $3 trillion invested in the industry² — may not have access to the potential benefits of active security selection. While fees are incredibly important, they should not be the sole determining factor in selecting a target date series. Recent litigation has highlighted the importance of relative returns and overall participant outcomes as well as absolute returns. Simply focusing on fees and costs is no longer enough to avoid litigation risk. And, more importantly, it may not provide the best outcome for participants.

Actively implemented target date funds have three levers to pursue favorable outcomes

Source: Capital Group. This is a hypothetical example for illustrative purposes only, not intended to portray an actual investment.

While strategic glide path differences between target date series are narrowing, other factors such as asset class allocations and active investment selection have played a greater role in affecting series outcomes and “plan sponsors and their consultants should focus on these factors” to better understand the disparity in target date outcomes.³

These factors are derived from an examination of the underlying funds, or “ingredients,” of an actively managed target date series, as the managers of these building blocks are responsible for fundamental security selection.

In the paper linked below, we take a closer look at the funds underlying the American Funds Target Date Retirement Series in terms of both return and risk to illustrate how they seek to drive better outcomes for participants.

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