Target Date Funds to bolster financial planning

When we plan for investments, the first and foremost activity is to know why one is investing for? What is the goal to be achieved is of prime importance as it decides what kind of investment avenue to opt for. Everyone has some common goals like children’s education, home/vehicle ownership and retirement, etc. Each of these goals have different timelines and so same avenues mayn’t work in the investors favor. One has to choose a combination of avenues i.e., the proportion of allocation varies even if the avenue is same.?

The active management of allocations among the assets and the rebalancing of their allocations depending on the market situation and especially the timelines is a tedious process. So, when we’re very sure of the timelines particularly for children’s education or even retirement then it’s easy to envisage the goal direction and which avenue to look for. Target-date funds (TDF) could achieve this with ease. These are the mutual funds (MF) or Exchange Traded Funds (ETF) which are designed to generate growth in a way that optimizes in a specific time frame.?

A target-date fund employs the traditional approach of asset allocation based on the timelines. For instance, if an investor will retire at a particular year and depending on the time left, it adjusts the asset allocation accordingly. So, as the time approaches, the investment strategy prioritizes capital preservation over appreciation whereas during the initial years the fund pursues appreciation aggressively. This means, the equity allocation decreases as the timeline nears. It also means the risk associated with the investment reduces towards the maturity as the portfolio is predominantly skewed towards debt.?

This to an extent is well-demonstrated in the National Pension Scheme (NPS) in the life-cycle option, though varied with three different choices. In the ‘auto-choice’, the NPS fund managers allow the investors who lack time or in-depth understanding of the investment management, allow the fund be operated on its own. The aggressive life cycle option allows the investors fund to be exposed to equity starting at 75% and goes down to 15% by the age of 55. In the moderate life cycle option, the equity component starts with 50% and goes down to 10% by the age of 55 while in the conservative life cycle option, equity starts at 25% going down to 5% by age 55.?

This pre-defined asset mix is known as glide path in a target-date fund. In NPS, the age of the subscriber is considered as the target date. A glide path acts as a roadmap on how the asset allocation is done in the fund. This allows the investor to assess what kind of risk a fund or investment option is associated with.?

Such funds allow the investors to not bother about their investment allocation and thus reduce the stress of actively managing their investment. Investors with limited time or knowledge about the markets could benefit from this. The target date generally being long-term, reduces the risk or effects of market gyrations.?

Though, planned for a defined need, there’s a chance of need being revised or changed due to the dynamics of life. Also, they could be expensive than the pure passive or mf due to the fund-of-fund nature. While they could turn less risky than the other active funds, there’s no guarantee that the goal is achieved by the maturity, as the returns are market linked. So, just because one has opted for a target-date fund, should completely ignore or not track the fund’s performance.?

Though prevalent in the advanced economies, in India we’ve very few options on this kind of funds.??In recent years, there have been some offerings like, Edelweiss NIFTY PSU Bond SDL Index Fund - 2026 which predominantly invests in debt instruments of AAA rated and State Development Bonds (SDL) in equal proportion. Nippon NIFTY SDL - 2026 invests in bonds of 20 different state governments and union territories with equal weightages. IDFC Gilt 2027 Index Fund and IDFC Gilt 2028 Fund invests in only those bonds that mature between 1st?May ’25 and 30th?Apr ’26 of central and state governments. With exposure to sovereign bonds, the credit risk is almost negligible in these funds, though are subject to volatility.?

These being mostly concerned with debt investments, are placed as an alternative to the bank fixed deposits (FD). With very low expense ratios they could be beneficial if the investor were to hold till the maturity, even as in the interim are subjected to mark-to-market risk. Though, investors into these funds are prone to interest rate risk in the short-term, would be mitigated, if held till the maturity. So, investors who’ve a clear defined timelines could opt for these funds that coincide with their needs.?

This article was originally published in "The Hans India" daily on 19th Sept '22.