October 30, 2012 (PLANSPONSOR.com) - Lyxor developed a new approach to target-date funds (TDFs) to
ensure proper retirement benefits.
In Lyxor Asset Management’s white paper, "How to Design
Target-Date Funds," the firm’s research arm, Lyxor Research, details an
approach to TDFs that takes into account allocation, portfolio theory and
As the firm points out, as people live longer, investors will
increasingly need to save sufficiently for retirement. In terms of pension
investment, the default funds offered by defined contribution (DC) plans are
proving popular. Investors are particularly attracted to TDFs (designed to suit
investors who will retire around a similar date) given their simple and
straightforward approach to saving.
TDFs are designed to collect the clients’ savings throughout their
entire working life, in order to maximize benefits in retirement. These funds’
allocation process takes the investor’s lifecycle into account. In DC pension
plans, younger participants invest, on average, 27% of their assets in such
Lyxor’s approach calls for TDFs to be aligned with modern
portfolio theory, not general industry consensus. Generally, these funds share
the same allocation behavior. They are mostly invested in equities at
inception, when investors are young, whereas the allocation will be more
heavily weighted toward bonds and cash as the clients approach retirement. This
behavior corresponds to popular advice in the financial industry, but Lyxor
said it lacked theoretical foundations until now. Modern portfolio theory says
that optimal investment decisions should not take the horizon into account.
Accordingly, investors should hold a constant proportion of equities and bonds
over time, which Lyxor said contradicts the general behavior of the industry.
Therefore, the allocation processes of TDFs remained unclearly motivated.
Investors should hold a stable proportion of their "human
capital" in equities over time. Lyxor research explains this industry
practice by the future income profile of investors. The research calls for
investors to invest a stable proportion of their "human capital" in
equities over time. So-called human capital is defined as the current capital
plus the present value of future savings. Human capital would outweigh current
capital for young investors, but both would converge as retirement approaches.
As such, Lyxor said the portfolio should be overweighed in equities for young
investors, in terms of current capital.