Overall, Target Date Fund (TDF) investors experienced positive returns for a second straight quarter. Investors further from retirement had returns generally in the 5.5%-7.5% range, while investors nearer retirement where in the 3%-5.5% range.
(Chart Source: Stadion)
A major driver of the range of returns is the amount of equity held in a particular vintage. Here is a chart of 2040 vintages with their allocation to equities on the horizontal and the vintage’s return on the vertical.
(Chart Source: Stadion)
You will notice an upward sloping trend in the data, denoting those vintages with a higher allocation to equities had stronger performance. This is naturally the case in quarters where equities outperform fixed income as was the case this quarter. But you will also notice vintages holding similar amounts of equity yet having vast differences in returns. An example is in the ~80% equity level, where some TDFs had closer to a 5.5% return whereas others had closer to a 7% return. So, outside the amount of equity/fixed income being held, we also need to dig into the type of equity/fixed income being held. I will dig into some common differences below:
US vs non-US Exposure:
TDF issuers can vary on the amount of US vs non-US exposure they carry, and generally we see a bit of home country bias and a higher US weighting vs a market weighted approach. For much of the quarter, US and non-US markets traded in line. However, the latter part of June saw US markets trade stronger and, as such, closed with an 8.9% return (measured by the MSCI USA index) vs 5.6% for the non-US markets (measured by the MSCI ACWI ex-US index). We will touch on some differences in US exposure later, but within non-US markets we saw almost equivalent returns in developed and emerging market exposure, both returning about 5.1% (as measured by MSCI EAFE and MSCI Emerging Markets).
Market Cap Exposure:
TDF issuers can also vary on the amount of large vs small Cap exposure held, and generally we see a bit more small cap exposure held than a market weighted approach. On the quarter, we saw large cap stocks lead the way, returning about 8.5% (as measured by both the S&P 500 and Russell 1000). Small cap stocks were trading in line until the latter part of June and then lagged, eventually returning in the 4.3%-4.5% range (as measured by the Russell 2000 and S&P SmallCap 600). Non-US markets did not see a similar divergence and trades mostly inline through the quarter, with small caps moderately outperforming depending on index family.
TDF issuers can also implement style tilts, whether it be explicit use of Growth vs Value underlying investments or implicit tilts within an actively managed offering. As was the case in other situations, we saw a divergence in performance in June, with growth stocks performing strongly while value stock languished. In the end, Growth stocks returned 11.9% (as measured by the S&P 500 Growth index) while Value stocks returned 5% (as measured by the S&P 500 Value index). While US small cap stocks did not see similar divergence, developed markets stocks did while to a less degree at +7.5% vs +3.2% (as measured by EAFE Growth index and EAFE Value index)
Fixed Income Exposure:
Shifting over to fixed income, the biggest difference we see between issuers is variations in duration exposure. This quarter we saw longer term rates trade significantly lower – about 0.30% – for the first time since last summer. Given the inverse relationship between rates and bond prices, this led to strong fixed income returns, particularly for longer-duration investors. 10-year treasuries returned 2% while 30-year treasuries returned 6.7% (as measured by ICE BofAML indices). Looking at quality, corporate bonds saw a bit stronger performance vs their treasury counterparts as spreads tightened in the latter half of June. Broadly, investment grade bonds returned about 0.5% more than duration-equivalent treasuries, while high yield bonds returned closer to 1.2% more.
So, where does that leave us heading into the 2nd half of the year? There seems to be a mix of optimism and pessimism in the market. Inflation fears seem to have tempered a bit. Fears regarding COVID and the Delta variant are increasing . The housing market remains elevated (for better or worse!). As we enjoy (or plod through) the rest of the summer, it will be interesting to see how things progress.
A target-date fund is a class of mutual funds or ETFs that periodically rebalances asset class weights to optimize risk and returns for predetermined time frame.
The MSCI EAFE Index (Europe, Australasia, Far East) is an unmanaged free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada.
The MSCI Emerging Markets Index consists of 23 economies including Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and the United Arab Emirates. The MSCI is a float-adjusted market capitalization index.
The MSCI ACWI ex USA Index captures large and mid cap representation across 22 of 23 Developed Markets (DM) countries (excluding the US) and 27 Emerging Markets (EM) countries. With 2,348 constituents, the index covers approximately 85% of the global equity opportunity set outside the US.
The MSCI USA Index is designed to measure the performance of the large and mid cap segments of the US market. With 627 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in the US.
The S&P 500 Index is the Standard & Poor’s Composite Index of 500 stocks and is a widely recognized, unmanaged index of common stock prices.
The S&P SmallCap 600 seeks to measure the small-cap segment of the U.S. equity market. The index is designed to track companies that meet specific inclusion criteria to ensure that they are liquid and financially viable.
S&P 500 Growth Index is a market-capitalization-weighted index developed by Standard and Poor’s consisting of those stocks within the S&P 500 Index that exhibit strong growth characteristics.
S&P 500 Value Index is a market-capitalization-weighted index developed by Standard and Poor’s consisting of those stocks within the S&P 500 Index that exhibit strong value characteristics.
The MSCI EAFE Growth Index captures large and mid cap securities exhibiting overall growth style characteristics across Developed Markets countries around the world, excluding the US and Canada. The growth investment style characteristics for index construction are defined using five variables: long-term forward EPS growth rate, short-term forward EPS growth rate, current internal growth rate and long-term historical EPS growth trend and long-term historical sales per share growth trend.
The MSCI EAFE Value Index captures large and mid cap securities exhibiting overall value style characteristics across Developed Markets countries around the world, excluding the US and Canada. The value investment style characteristics for index construction are defined using three variables: book value to price, 12-month forward earnings to price and dividend yield.
The 10-year Treasury note is a debt obligation issued by the United States government with a maturity of 10 years upon initial issuance.
The 30-year Treasury note is a debt obligation issued by the United States government with a maturity of 30 years upon initial issuance.
The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represents approximately 8% of the total market capitalization of the Russell 3000 Index.
The Russell 1000 Index is a comprehensive large-cap index measuring the performance of the largest 1,000 U.S. incorporated companies, the Russell 1000 Index is reconstituted completely on an annual basis to ensure the index measure the large cap segment consistently and objectively over time. Each security in the Russell 1000 is float-adjusted market capitalization-weighted to ensure investable positions.
Growth stocks are those companies expected to grow sales and earnings at a faster rate than the market average.
Value stocks are shares of a company that appears to trade at a lower price relative to its fundamentals, such as dividends, earnings, or sales.
Large cap refers to a company with a market capitalization value of more than $10 billion.
A small cap is generally a company with a market capitalization of between $300 million and $2 billion.
Investment Grade bonds are those which are believed to have a low risk of default and receive higher ratings by credit rating agencies. These bonds tend to be issued at lower yields than less creditworthy bonds.
High-yield bonds are rated below investment grade by credit rating agencies. These bonds have a higher risk of default or other adverse credit events, but offer higher yields than investment-grade bonds.
The ICE BofAML Fixed Income Indices track the performance of the global investment grade, high-yield and emerging debt markets.
There are certain limitations to technical analysis research, such as the calculation results being impacted by changes in security price during periods of market volatility. Technical measurements are one of many indicators that may be used to analyze market data for investing purposes and should not be considered a guaranteed prediction of market activity.
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