Target-date funds are the key to the future of retirement savings for American workers. While these funds have seen tremendous asset growth over the past decade, their investment design hasn’t kept pace with available innovations. The result: many target-date strategies may fail to guard against today’s heightened retirement risks.

It’s time to revisit target-date fund designs and single-manager structures. Most retirement plans still use traditional designs that were adopted years ago, but fiduciary standards have changed. In fact, the US Department of Labor (DOL) has issued “Target Date Retirement Funds: Tips for ERISA Plan Fiduciaries,” which highlights the need for plan sponsors to have a solid process for selecting and monitoring their target-date choice.

The investment environment has changed, too. A broader range of strategies is now available and time-tested, beyond traditional equity and fixed income. These strategies can help reduce sensitivity to market, interest-rate and inflation risks at different points in the glide path. And diversifying against these risks can improve overall outcomes versus a traditional glide path roughly 80% of the time.

We see five key areas (Display below) for evolving the state of target-date design:

• Moving from a single investment manager to a multi-manager or open-architecture format to access best-of-breed managers and reduce concentration risk

• Diversifying the underlying investment mix from a traditional stock/bond glide path to incorporate nontraditional asset classes, too
• Providing greater flexibility to respond to short-term market fluctuations with a dynamic, rather than static, approach
• Mixing active and passive investing strategies to enhance risk-adjusted returns and manage costs
• Calibrating the glide path to deliver better results in the distribution phase of a retirement plan—a critical but often overlooked component of any retirement solution

AB has already applied these research insights to create better target-date solutions for large institutional retirement plans. We believe that this design will be the future of target-date funds for plans of all sizes.

Updating Retirement Reality

Ten years ago, we published our first blueprint for target-date design. It was based on thorough research and a detailed analysis of what we found to be best practices for constructing a sensible glide path. A lot has changed since then. There are new tools available—new asset classes, new approaches to handling volatile market conditions and new interest in open-architecture structures that accommodate multiple investment managers. Most importantly, the Pension Protection Act of 2006 and regulations from the DOL gave new support to three types of all-in-one portfolios—target-date funds, balanced funds and managed accounts. These steps essentially blessed these asset-allocation investments as qualified default investment alternatives (QDIAs) with safe-harbor protections.