funds and both purport to control risk by managing the amount invested in debt and
equity, but they do it in very different ways. Target risk funds (TRFs) are generally fund
of funds which attempt to hold the proportions invested in debt and equity constant over
time. These funds are sometimes called lifestyle funds. The name of the fund usually
contains reference to the intended risk, e.g., conservative, moderate or aggressive. Target
date funds (TDFs) change the proportion invested in debt overtime to reduce risk as a
speciﬁed date approaches. Both types of funds purport to control risk by controlling the
fund’s debt-to-equity ratio.
A lot has been written about TDFs, both in the popular press
and in the academic literature, while TRFs have been largely ignored. The attention paid
to TDFs has been fed by their recent growth and their increasing use as an option in 401
(k) plans. However, the theoretical models examining asset allocation over time provide
both supporting and contradictory evidence as to whether increasing the debt-to-equity
ratio over time is optimal.
In addition, time to retirement is not the only factor that
should be considered by the investor making asset allocation decisions: labour income,
wealth, and especially risk preference may be important.
The most comprehensive empirical study of the optimality of target date funds
increasing the ratio of debt to equity over time is Poterba et al. (2005). They include
labour income and non 401(k) wealth in their examination of the utility of wealth at
retirement. They simulate the time path of asset returns using historical index data as well
as data where the stock return is 300 basis points less than the historical return. They
show that a constant-debt-to-equity strategy, which is the strategy followed by target risk
funds has a higher utility of terminal wealth than the decreasing-debt-to-equity strategy
followed by target date funds. We will examine this subject later in the paper using actual
data on the performance of TRFs and TDFs.
Thus both theory and empirical evidence suggests that target risk funds which hold the
debt-to-equity ratio constant over time may be a viable alternative to target date funds for
inclusion in retirement plans. In fact in 2014, 43% of the assets in TRFs were held by
retirement accounts. In addition, target risk funds are important in their own right. In
2014 they had over US$394 billion under management. Their growth rate in the period
2008–2014 was 14.4% per year, while assets under management by all mutual funds
grew by 8.7% per year. It was not until 2009 that TDFs had more assets under
management than TRFs, and it was not until 2008 that there was a larger number of TDFs
than there were of TRFs. Despite the number of TRFs, their size, their reasonableness as
an alternative to target date funds in retirement plans, and their use in retirement plans,
TRFs have not been carefully studied.
This article is the ﬁrst comprehensive study of the characteristics and performance of
target risk funds. While there have been a number of studies of other asset allocation
funds, these other categories of asset allocation fund do not in general attempt to hold the
debt-to-equity ratio constant and are not offered by a fund family alongside other funds
attempting to hold the debt-to-equity ratio constant at alternative levels. An additional
purpose of this article is to analyse whether target risk funds are a reasonable alternative
to target date funds. This article is divided into seven further sections. In section 2, we
describe the sample of funds used throughout this paper. In section 3, we examine the
See for example the glide path presented by most target date funds.
See Bodie et al. (1991), Campbell and Viceira (2002), Campbell et al. (2001), Cocco et al.
(2005), Madrian and Shea (2001), Merton (1969) and Shiller (2005).
© 2016 John Wiley & Sons, Ltd.
520 Edwin J. Elton, Martin J. Gruber and Andre de Souza