DESIGNED FOR THE JOURNEY OF A LIFETIME

Target Date Funds

How TDFs compare with traditional strategies

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A CHANGING PENSION-FUND LANDSCAPE

Back when the journey from work through to retirement seemed more certain, the lifestyle strategy was a major innovation for pension-fund providers. By reducing risk as the age of retirement came closer, lifestyle strategies offered a novel means of sheltering investors from market volatility as their investment approached maturity.

Since lifestyle strategies began to be adopted in the 1980s, pension products have undergone considerable evolution. Although lifestyle strategies are still widely used, they are cumbersome to administer and their derisking processes are simplistic. Accordingly, successive innovations, such as blending and diversified growth funds, have built on the foundation provided by the lifestyle strategy. But although these are positive developments, they also bring complexity and cost, so they have not replaced lifestyle strategies for the majority as the default option of choice for pension-fund trustees.

More recently, the market evolution has brought the creation of target date funds (TDFs) and in particular, flexible TDFs. Designed to reflect the realities of a complex and shifting investment landscape, TDFs offer greater sophistication, transparency and flexibility than lifestyle strategies. In this guide, we explore the advantages that flexible TDFs offer over traditional lifestyle strategies.

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TARGET DATE FUNDS 1

TDFS VS. LIFESTYLE FUNDS: THE BASICSA TDF is a single fund managed according to the expected retirement window (e.g. the 2033 to 2035 fund) when members are likely to access their savings. Investors choose, or more often are defaulted into, the TDF that best reflects their retirement horizon. The TDF is designed to manage investment risk as that date approaches—so that risk is reduced as retirement comes closer.

Crucially, most TDFs have fund managers who can take proactive strategic and tactical decisions with regard to risk and asset allocation. This offers investors the opportunity to benefit from favourable market conditions at any stage in the life of their investment—or indeed take shelter in lower-risk asset classes if market conditions are less favourable. In this regard, a TDF can be thought of simply as an age-based multi-asset fund.

A lifestyle strategy, in contrast, invests in a group of funds and targets a specific retirement date. As that date approaches, the portfolio of funds is de-risked according to a set process—typically, by switching out of equities and into long-dated bonds.

Because the de-risking process takes place automatically, the strategy is unable to take market conditions into account—this could disadvantage investors. In addition, changes in asset allocation are performed by the administrator, who has to make the changes for each individual account; as there could be thousands of these in a given scheme, this makes any changes time-consuming and costly.

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AGILITYUnlike lifestyle strategies, TDFs are designed to adapt to changing market conditions. For that reason, they are managed by investment professionals who take day-to-day decisions that can improve the performance of the funds. And they can take action quickly and efficiently to ensure that the portfolio represents the best interests of investors.

In contrast, a lifestyle strategy depends on the pension fund’s trustees or provider to take asset-allocation decisions. As trustees aren’t usually full-time investment professionals who deal with the markets day in, day out, trustees tend to be slow in making and implementing decisions. As a result, lifestyle strategies are notoriously cumbersome when reacting to market events.

Furthermore, lifestyle strategies focus on a fixed end date and alter their investment approach according to a preordained process—even if market conditions render that process unfavourable

FLEXIBILITYTDFs acknowledge that investors have differing objectives and may also change their views on retirement as their careers progress.

Research shows that most people are unsure about the exact date on which they will retire. The huge range of available TDFs allows investors to choose the approach that best fits their circumstances. And because a two-to-three-year ‘window’ is selected rather than a specific

retirement date, there is more room for manoeuvre as plans change. Should an investor’s retirement plans change more significantly, it’s easy to switch to another TDF that is more suitable for the new circumstances. In any case, the TDF will carry on managing investors’ money until they are ready to decide.

SIMPLICITYAnother compelling attraction of TDFs is their simplicity. Investors need make only a single investment and do not have to consider complexities such as the appropriate mix of asset classes. This ‘one-stop shop’ aspect makes TDFs easy to understand for both employers and scheme members. The simple and intuitive nature of TDFs is in contrast to lifestyle strategies, with their combination of several different funds.

The simple structure also means that investors are freed from close involvement with their investment. For many, this is a considerable further attraction. Once the investment is made, investors only need to take action if their planned retirement dates change. Otherwise, they can leave all decision-making to the TDF’s professional investment manager.

GREATER SOPHISTICATIONA key difference between TDFs and lifestyle strategies is that TDFs are managed by investment professionals whose job it is to make day-to-day decisions about the running of the fund. Those professionals are employed to provide

SIX REASONS WHY TDFS ARE MORE EFFECTIVE TDFs offer six key advantages over traditional lifestyle strategies.

+ Agile and responsive to changing market environments+ Flexibility to manoeuvre if members’ retirement plans change+ Simple and easy for members to understand+ Managed and governed by professional investors+ Adapt quickly and decisively to regulatory changes+ Offer transparent and clear communication

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TARGET DATE FUNDS 3

proactive management, so that the TDF can react to—and anticipate—changes in the investment environment.

The benefits of this are particularly clear when it comes to asset allocation. A TDF’s manager makes asset-allocation decisions based on market experience and current market conditions. In contrast, the lifestyle strategy’s asset allocation is decided by the pension fund’s trustees, who may lack direct market experience.

Furthermore, TDFs benefit from the alignment of investors’ interests with those of their managers, as the managers are rewarded if the funds perform well. This leads to more efficient risk management. It can also potentially lower transaction costs, as the manager is able to maximise efficiency in the day-to-day operations of the fund.

FUTURE PROOFINGAs the past two years have shown, pension regulations can change rapidly and radically. Lifestyle strategies can be painfully slow to react to such changes. But TDFs, with their proactive and professional management, can adapt quickly and decisively to developments in the regulatory regime. This mirrors the way in which TDFs can react to changes in the investment environment. In both cases, proactive management allows TDFs to take unexpected developments in their stride.

TDFs enjoy this advantage over lifestyle products because their managers can take decisions without seeking authorisation from anyone else. The managers of lifestyle funds, in contrast, often have to ask for permission from trustees and end-investors—a process that can sometimes take months.

The cost of change is also significantly reduced with TDFs, as they are designed to be efficient when dealing with regulatory change. They can make substantial shifts in asset allocation without having to involve record keepers and lawyers, and without the need for laborious communication with a wide range of parties. Whereas a lifestyle strategy might need months and entail significant expense to react to a major regulatory development, such as the 2014 Budget, a TDF’s managers can reposition the fund in just a few days. This allows members’ investments to be future-proofed against forthcoming developments as they appear on the horizon.

GREATER TRANSPARENCYAs a TDF is a single fund, it is more easily understood than the combination of funds that make up a lifestyle strategy. Because each member of the scheme invests in a single fund, it’s easier to understand what is being done with their investment and why. It’s also clear when the fund is working well. This leads to clearer communication and greater transparency for the individual investor.

TARGET DATE FUND PERFORMANCE Since Inception 1 January 2011–30 June 2015

0%

2%

4%

6%

8%

10%

2.5% 5.0% 7.5% 10.0% 12.5%Risk (Annualised Monthly Return Volatility)

Annu

alis

ed R

etur

n (g

ross

of f

ees)

2014–20162023–2025 2032–2034

2041–2043

Annuity + Cash

MSCI World

FTSE All-Share

Gilts

Source: ABPast performance is no indication of future results.

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NOT ALL TDFS ARE THE SAME

As with any broad product category, there is considerable variation between different types of TDF. As with other investment funds, TDFs offer a wide range of investment approaches, including both active and passive strategies.

It’s important for clients to choose the TDFs that are suited to their retirement objectives.

In this regard, flexible TDFs, which have evolved from original TDFs, have particular attractions for pension-fund investors.

TRUSTEE CONTROLThese funds allow trustees to keep control of fund construction, which is carried out independently of the TDF manager. This ensures that the fund is fully aligned with the trustees’ objectives—but also that the benefits of an independent, professional manager are retained.

OPEN ARCHITECTUREFlexible TDFs also offer open architecture. When multi-asset TDFs are built, the available components are not restricted to those offered by the TDF manager. Instead, the trustees are able to choose from the best available investment managers.

MORE TRANSPARENTFinally, as with all TDFs, the simplicity of structure provided by a flexible TDF leads to a clearer, more transparent solution—for both the pension-fund trustees and the scheme members.

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TARGET DATE FUNDS 5

FULLY CUSTOMISABLEAlthough flexible TDFs do not provide the same degree of individualisation as lifestyle strategies, they do offer customisation to cater for investment objectives that are specific to a pension scheme’s membership. As full individualisation is of dubious value, this creates a good balance between ‘off-the-peg’ and ‘bespoke’ solutions for individual pension schemes. And throughout the

TDF’s lifespan, risk is carefully controlled as the fund progresses along its ‘glidepath’ towards the retirement date. This is achieved through active management of the TDF’s component funds with regard to the scheme’s objectives. All in all, this delivers a solution that is effectively bespoke and—more importantly—can evolve with the needs of the individual pension scheme.

ALIGNMENT OF INTERESTSThe interests of a flexible TDFs manager are closely aligned with those of the client. This leads to more efficient and effective risk management, as the manager is incentivised to ensure that risk remains within the levels set out by the trustees. Of equal importance is the reduction in transaction costs that arises from the manager's interest in maximising the fund’s net returns.

BETTER OUTCOMESFlexible TDFs may not be the cheapest option in the marketplace. But the management fees represent only a superficially higher cost for the client, because of the savings afforded by more efficient transaction costs and the efficient allocation of the investment budget that use of a flexible TDF entails. This effectively underwrites the cost of future change. Therefore, the combination of lower administration costs and reduced disruption to the scheme members’ lives over time results not only in a smoother investment outcome, but in a better journey as well.

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This document is issued by AllianceBernstein Limited, 50 Berkeley Street, London W1J 8HA, a company registered in England under company number 2551144. AllianceBernstein Limited is authorised and regulated in the UK by the Financial Conduct Authority (FCA – Reference Number 147956). This document is directed at Professional Clients only. It is provided for informational purposes only and does not constitute investment advice or an invitation to purchase any security or other investment. The views and opinions expressed in this document are based on our internal forecasts and should not be relied upon as an indication of future market performance. Past performance is no guarantee of future returns. This document is not intended for public use.A WORD ABOUT RISK Market Risk: The market values of the investments may rise and fall from day to day, so investments may lose value.Interest Rate Risk: Bonds may lose value if interest rates rise or fall—long-duration bonds tend to rise and fall more than short-duration bonds.Credit Risk: A bond’s credit rating reflects the issuer’s ability to make timely payments of interest or capital—the lower the rating, the higher the risk of default. If the issuer’s financial strength deteriorates, the issuer’s rating may be lowered and the bond’s value may decline.Allocation Risk: Allocating to different types of assets may have a large impact on returns if one of these asset classes significantly underperforms the others.Foreign Risk: Investing in overseas assets may be more volatile because of political, regulatory, market and economic uncertainties associated with them. These risks are magnified in assets of emerging or developing markets.Currency Risk: Currency fluctuations may have a large impact on returns and the value of an investment may be negatively affected when translated into the currency in which the initial investment was made.Capitalization Size Risk: Holdings in smaller companies are often more volatile than holdings in larger ones.We have referred to Retirement Bridge funds in this piece for ease of reference. Retirement Bridge is a separately managed account service provided to the trustees by the investment manager. For further information, contact your local pension representative.Retirement Bridge (RB) is an investment service provided to trustees by AllianceBernstein. The RB account is offered under a pooled custody arrangement for the benefit of investors in RB. Trustees access the RB service by entering into a discretionary investment management agreement with AllianceBernstein. Each RB account in the RB series is comprised of a combination of underlying funds managed by AllianceBernstein and other external fund managers as well as other direct investments. Trustees should note that assets invested in funds remain exposed to market risk and there is no guarantee that income payout rates will be maintained.Target Date Retirement Funds (the “Fund(s)”) referenced above are designed for a typical pension fund saver intending to retire in or around the years stated in the name of the Fund. As the Funds are intended to be default pension saving vehicles which seek to meet the requirements of a broad range of persons, they do not take into account an individual’s personal circumstances and may not be suitable for a particular individual or group of individuals with complex financial or personal circumstances.AB has chosen AXA Wealth Limited* (“AXA Wealth”) to provide a range of blended funds which have an underlying asset allocation strategy designed by AB. AXA Wealth provides access to blended funds that invest in underlying funds and assets. AB have designed the underlying asset allocation strategy of the blended funds. The underlying funds held within each blended fund solution will be determined by AXA Wealth and AB. AXA Wealth will provide access to the range of blended funds to AB and its respective distribution channels. AXA Wealth will make the blended funds available to the investors via an insurance contract under which the benefits payable are linked to the performance of the underlying funds and other assets.Accordingly, the interests in the underlying funds held within each blended fund solution are owned by AXA Wealth and investors will not have any legal or beneficial ownership in such underlying funds. The returns described above or for any blended fund product are, therefore, dependent on AXA Wealth being able to meet its obligations under the life insurance contract. In the event of AXA Wealth being unable to meet its obligations, compensation, subject to eligibility criteria and limits, may be available from the Financial Services Compensation Scheme.*AXA Wealth, Winterthur Way, Basingstoke RG21 6SZ. Telephone number: 01256 470707. As part of AXA Wealth’s commitment to quality service and security, telephone calls may be recorded. AXA Wealth is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and Prudential Regulation Authority and is a company limited by shares. Registered in England No. 01225468. The registered office is 5 Old Broad Street, London EC2N 1AD.MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.The [A/B] logo is a service mark of AllianceBernstein and AllianceBernstein® is a registered trademark used by permission of the owner, AllianceBernstein L.P. © 2015 AllianceBernstein.

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