Professional Investor | Feature
in occupational pensions) do not. Financial education is not
sufficient to change this behavioural aspect, hence TDFs are
designed to correct this, by remaining typically appropriate to a
particular age group or target date, all other things being equal.
Second, the asset allocation models are professionally
managed, built on both investment theory and fund
management practice. This leads to markedly different asset
allocation profile compared to traditional balanced funds, and a
more scientific approach to risk control.
Third, the pooling together of a peer group’s savings for a
particular aspiration creates substantial scale benefits, which
helps deliver TDFs at similar or lower costs to individually
managed traditional funds, while providing, in addition, ongoing
fiduciary oversight.
Last, compared to heterogeneous investment strategies devised
and reviewed by individual IFAs, TDFs offer a level of design
homogeneity that creates some consistency in the market for
asset allocation best practice.
The main disadvantage of TDFs is clear and not hidden:
not all investors are typical, and many may prefer a bespoke
portfolio customised to their specific needs and attitude to risk
as regularly reviewed by their investment adviser. However, this
comes and will continue to come at a premium cost. Post-RDR
the cost of such bespoke services will be made explicit, so the
cost-benefit decision of whether to pay for bespoke advice
remains a choice investors can and should make for themselves.
For UK regulators, it is helpful that the debate on the pros and
cons of TDFs have been extensively rehearsed in the joint SEC/
Department of Labor public hearings in 2009, and subsequent
SEC recommendations on TDFs in 2010. The conclusions
were that while TDFs offered simplicity that made them a
popular and welcome investment innovation, managers must
give prominent and detailed asset allocation disclosures and
reiterate to potential or existing investors the need to consider
continually TDFs’ appropriateness versus their broader financial
circumstances such as risk tolerance, tax position, financial
situation, risk tolerance and life expectancy.
“ TDFs offer a level of design
homogeneity that creates some
consistency in the market for asset
allocation best practice.”
WHY DID THEY TAKE THE US MARKET BY STORM?
The TDF revolution gained momentum when auto-enrolment
was introduced with the US Pensions Protection Act 2006.
TDF assets grew from $71 billion in 2005 to $340 billion
by end of 2010 (Morningstar 2011), or approximately 9%
of pension assets (ICI 2011, and our estimates). In terms of
popularity for new participants, some 94% of US DC pensions
plans now use TDFs as default funds, compared to just 4% in
the UK (DCisions, 2011).
The 2006 Act created the necessary legislation for autoenrolment and safe-harbour investments described by the
Department of Labor as “Qualifying Default Investment
Alternatives” or QDIAs. Providing a QDIA protects employers
from liability of losses suffered by automatically-enrolled
The Journal of the CFA Society of the UK | www.cfauk.org | 45