target-date funds laying a critical foundation for ... · actual investment results, and are not...

For Institutional and Accredited Investor Use Only. Not for Public Distribution.

Target-date fundsLaying a critical foundation for retirement successJohn Croke, CFAHead of Multi-Asset Product Management, The Vanguard Group

15th FIAP International Seminar, Mexico City

October 30, 2017

2For Institutional and Accredited Investor Use Only. Not for Public Distribution.

15th FIAP/AMAFORE International Seminar

• A refresher on target-date fund design

• Reminding ourselves why TDFs exist in the first place

• Solving the decumulation riddle – a global quest

• Focusing on the things you can actually control

• You can never invest your way out of a savings deficit

Agenda



Melbourne

Sydney

Brisbane

Singapore

TokyoValley Forge

London

Paris

Amsterdam

Hong Kong

Zurich

Toronto

CharlotteScottsdale

Beijing

Washington D.C.

Shanghai

Mexico City

Our mission

To take a stand for all investors, to treat them fairly,

and to give them the best chance for investment success.

Source: The Vanguard Group, Inc., as of August 31, 2017, except number of offices, which is as of October 2, 2017. Asset figures are in USD.

$4.6 trillion under management

371 mutual funds and ETFs

20 million clients in 170 countries

15,000 employees

18 offices



$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,800

1994 2017Q2

Asse

ts u

nd

er

ma

na

ge

me

nt

in $

B

Annual target-date assets under management since 1994

Vanguard is the global leader in target-date funds

Vanguard Fidelity Investments

BlackRock T. Rowe Price

JPMorgan Other

⅓60%

90%

Industry AUM

Industry cash flow

since 2016

Industry index-based

cash flow since 2016

Sources: Vanguard and Morningstar, as of June 30, 2017. Sources: Vanguard, Morningstar, company public filings, as of June 30, 2017. Figures based on U.S. funds.



A refresher on target-date fund design



• Long-term investors are rewarded for taking market risk

• Total wealth includes both financial assets and human capital

• As human capital declines with age, investors should take less risk in their financial assets

• A well-designed target-date fund should be built on both sound financial theory and investor behavior

The foundational principles of target-date fund design



Long-term investors are rewarded for taking market risk

-60%

-40%

-20%

0%

20%

40%

60%

1-Year 3-Year 5-Year 10-Year 20-Year 30-Year 40-Year

Range of excess returns Average excess return

Historical equity risk premium over different time periods, 1926–2016

An

nu

alized

exce

ss s

tock r

etu

rn v

ers

us r

etu

rn

for

no

min

al b

on

ds

Notes: Past performance is no guarantee of future results. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index. U.S. stock market returns are represented by the

Standard & Poors 90 from 1926 through March 3, 1957; the Standard & Poors 500 Index from March 4, 1957, through 1974; the Wilshire 5000 Index from 1975 through April 22, 2005; the MSCI US Broad Market Index from April 23, 2005,

through June 2, 2013; and the CRSP US Total Market Index thereafter. U.S. bond market returns are represented by the Standard & Poors High Grade Corporate Index from 1926 to 1968; the Citigroup High Grade Index from 1969 to 1972;

the Lehman Brothers US Long Credit AA Index from 1973 to 1975; the Barclays Capital U.S. Aggregate Bond Index from 1976 to 2009; and the Spliced Barclays U.S. Aggregate Float Adjusted Bond Index thereafter.

Source: Vanguard calculations, based on data from Standard & Poor’s, Wilshire, MSCI, CRSP, Citigroup, and Barclays.



As human capital declines with age, investors should take less risk in their financial assets

Source: Vanguard.

Human capital

An individual’s opportunity

to earn and save money.

This diminishes over time.

Financial capital

An individual’s total saved

assets.

Age 25 Age 45 Age 65 Age 85 Age 100

Retirement

date

Human

capital +

financial

capital =

total

economic

wealth



0

20

40

60

80

100%

25 30 35 40 45 50 55 60 65 70 75 80 85 90 95

Age

Equity

allo

cation

Young Transition Retirement Late retirement

Younger than 40

Up to age 40 will have a

high equity allocation (90%)

41–65

Gradually moves to a

50% stocks/50% bonds

allocation

at age 65

66–72

Shift

inflation

hedge mix

away from

stocks and

toward

TIPS

72+

Modest (30%) continued

exposure to stocks

Phase I Phase II Phase III Phase IV

Target date*

The glide path sets the exposure to risky assets (i.e. equities) throughout the investor’s life cycle

* Target date is the year stated in the fund name. Target-date fund allocations are based on a projected retirement age of 65.



“To retirement” TDFs… “Through retirement” TDFs…

Perc

enta

ge

allo

cation to r

isky a

ssets

Age 65

The glide path “de-risks” to the point of retirement

Age 65Perc

enta

ge

allo

cation to r

isky a

ssets

The glide path “de-risks” through the point of

retirement

The rationale for “to” TDFs

• Human capital is zero at retirement

• Many participants withdraw assets from their employer retirement plans at retirement

The rationale for “through” TDFs

• Empirical data showing DC wealth is not converted to retirement income until members are in their early 70s

• Desire to capture more of the equity risk premium before wealth is drawn down

The “to” vs. “through” debate: The intersection of financial theory and observable investor behavior



0%

20%

40%

60%

80%

100%

Pe

rce

nta

ge

of tr

ad

itio

na

l IR

A h

old

ers

wh

o

ha

d w

ith

dra

wa

ls

Remain in the plan

Rolled over

Held in cash

0%

20%

40%

60%

80%

100%

1 2 3 4 5

Pe

rce

nta

ge

of a

sse

ts

Years after retirement

Source: Retirement distribution decisions among DC participants, Vanguard, October 2016.

Investor behavior drives Vanguard’s “through retirement” approach to its U.S. target-date funds

Yes, 5 years after retirement 75% of assets have left the plan, but…

. . . investors do not withdraw money after rolling over until around age 72



Reminding ourselves why TDFs exist in the

first place



Left to their own devices, many investors arrive at extreme asset allocations

Past performance is not a guarantee of future results.

Source: Vanguard, How America Saves 2017.

Note: Includes a random sample of 1,000 participant accounts drawn from respective samples. Excludes 0.5% top and 0.5% bottom outliers for both risk and return, for a net sample of 980 observations. Vanguard defined contribution plan

participants for the five-year period ended December 31, 2016.

Note: U.S. stocks represented by the MSCI US Broad Market Index; U.S. bonds represented by the Barclays U.S. Aggregate Bond Index; International stocks represented by the MSCI All Country World Index ex USA.

Accumulation phase / auto features

Participants younger than 35 years of age

Participants ages 35 to 55

Participants older than 55 years of age

Fiv

e-y

ea

r a

nn

ua

lized

to

tal r

etu

rn

Five-year annualized standard deviation

Fiv

e-y

ea

r a

nn

ua

lized

to

tal r

etu

rn


TDFs enable average investors to benefit from more efficient risk-return trade-offs

0%

20%

0% 25%

U.S. bonds

Non-U.S. stocks

U.S. stocks

0%

20%

0% 25%

U.S. bonds

Non-U.S. stocks

U.S. stocks

Fiv

e-y

ea

r a

nn

ua

lized

to

tal r

etu

rn


Fiv

e-y

ea

r a

nn

ua

lized

to

tal r

etu

rn




Australian bonds

Australian shares

International shares

0%

20%

0% 14%

Self-directed members…Life-cycle members…

A similar story can be seen in Australia’s superannuation system

Past performance is not a guarantee of future results.

Source: How Australia Saves 2017, Vanguard.

Note: Australian shares represented by the S&P/ASX 300 Index; Australian bonds represented by the Bloomberg AusBond Composite 0+ Yr Index; international shares represented by the MSCI World ex-Australia Index. a random sample of

1,000 participant accounts drawn from respective samples. Excludes 0.5% top and 0.5% bottom outliers for both risk and return, for a net sample of 980 observations. SunSuper members for the five-year period ended June 30, 2016.

Australianbonds

Australian shares

International shares

0%

20%

0% 14%

Fiv

e-y

ea

r a

nn

ua

lized

tota

l re

turn

Fiv

e-y

ea

r a

nn

ua

lized

tota

l re

turn

Members age <55

Members age 55+

Five-year annualized

standard deviation

Five-year annualized

standard deviation



What my TDF knows about me….

6%

Personal Identification Number: XXXXXExpected retirement: ~ 2045

What my TDF does not know about me….



Solving the decumulation riddle – a global

quest



What’s fueling the urgency around “retirement income” and "decumulation"?

Sources: U.S. Census Bureau, World Health Organization, historical returns computed by Vanguard, expected returns are estimated using the Vanguard Capital Markets Model (VCMM). IMPORTANT: The projections or other information generated by Vanguard Capital Markets Model® (VCMM) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary with each use and over time. Please see the Important information slide for additional information about VCMM.

Demographics

Central & South American population > 65 years

2000

5.5%

2017

7.9%

2050 (est.)

18.7%

Longevity

Life expectancy in years at age 60 for the Americas

2000

20.9

2017

22.8

Lower returns

Annualized returns on a portfolio of 60% stocks / 40% bonds

1926 to 2016

8.5% p.a.

Est. 10-year (median outcome)

5.6% p.a.



Access to guaranteed income in retirement is declining (or in many markets, never existed)

Source: Willis Towers Watson Global Pension Asset Study 2017.

4%

5%

6%

18%

60%

87%

96%

95%

94%

82%

40%

13%

0% 20% 40% 60% 80% 100%

Japan

Canada

Netherlands

UK

United States

Australia

Share of defined contribution versus defined benefit assets across major markets

DC DB



What factors determine success in decumulation?

Asset allocation Drawdown rate Long-term medical care expenses ($90K / year)

IMPORTANT: The projections or other information generated by Vanguard Capital Markets Model® (VCMM) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment

results, and are not guarantees of future results. Results may vary with each use and over time. Please see the Important information slide for additional information about VCMM.

Notes: Salary projections are derived from the Social Security Administration’s Wage Index, an index that accounts for factors like career advancement. The index is grown by 1.1% annually, on a real basis, which is representative of the

U.S. economy’s historical productivity growth. Age-specific contribution rates are derived from How America Saves 2014 (The Vanguard Group, 2014), a report surveying 3 million participants served by Vanguard's recordkeeping business.

Contributions are assumed to start at an average rate of 4.88% at age 25, increasing to an average rate of 9.98% by age 64. Over the employee’s career, the average contribution rate is 7.2%. We assume a company match of $0.50 on the

dollar up to 3%, which is consistent with industry averages. Replacement ratios are drawn from the work of Aon Consulting (with data taken from the U.S. Department of Labor’s Bureau of Labor Statistics “Consumer Expenditure Survey”) to

assign appropriate replacement ratios based on retirees’ age-65 income.

Impact on success in year 35 of retirement from changes to the…

86%82%

91%

76% 74%

61%

30% Equity / 70%Bonds

70% Equity / 30%Bonds

4.50% Withdrawalrate

5.50% Withdrawalrate

In year 9 In years 9 & 10



Focusing on the things you can

actually control



Vanguard’s mission: to take a stand for all investors, to treat them fairly, and to give them the best chance for investment success

This mission anchors the design principles of the Vanguard Target Retirement Funds & Trusts:

Source: Vanguard.

Build enduring

investment

portfolios

Help investors reach

their goals through

a holistic approach

Deliver a defendable

solution that is

globally diversified,

transparent, and low

cost



Source: Vanguard.

* Target date is the year stated in the fund name. Target-date fund allocations are based on a projected retirement age of 65.

Transparent, straightforward asset-class exposure



Many moving parts—25+ sub-asset classes

Fewer moving parts—5 index funds

Two different lenses to portfolio construction

Vanguard target-date funds offer the simplicity of an index-oriented, well-diversified portfolio that is strategic and straightforward in its approach. The funds are composed of up to five underlying funds and follow

an easy-to-understand asset allocation glide path. Underlying this simplicity is Vanguard's deep investment expertise, knowledge of the capital markets, and insights into participant behavior.

Sources: Hypothetical target asset allocations per the glide path of a 2015 target-date fund. Sub-asset allocations determined using data from Vanguard and Morningstar as of March 31, 2017.

26.8% Total U.S. stock market index

31.6% Total U.S. bond market index

17.9% Total non-U.S. stock index

13.4% Total non-U.S. bond index

10.3% Short-term inflation-protected securities index

U.S. stocks U.S. nominal bonds

8.3% Large growth 13.8% Treasury/Agency

9.8% Large value 6.6% Government mortgage-backed

0.8% Large blend 8.7% Corporate

2.7% Mid/Small growth 1.8% Foreign

3.5% Mid/Small value 0.6% Commercial mortgage/Asset-backed

0.6% Mid/Small blend 0.1% Other

1.1% U.S. REITs

International stocks

7.4% Europe

4.9% Pacific

3.1% Emerging markets

1.2% North America

0.5% Middle East/Other

0.7% Non-U.S. REITs

International nominal bonds

7.4% Europe

3.8% Pacific

1.1% North America

0.5% Emerging markets

0.6% Middle East/Other

10.3% Short-term TIPS



You can never invest your way out of a

savings deficit



Meaningful changes in glide path design only have a marginal impact on success in decumulation…

“Conservative” glide path Baseline glide path “Aggressive” glide path

91% 92% 92%

Probability of positive balance at age 95








100%

90%

80%

40%

30%

20%

Sto

ck a

llo

ca

tio

n

Time to retirement



…however, there is much greater power in the savings rate

8.8%








Reduced savings rate Baseline savings rate Increased savings rate

86% 92% 95%

Probability of positive balance at age 95

7.2%5.7%



The information contained herein is for educational purposes only and does not constitute an offer or solicitation and may not be treated as an offer or solicitation in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so.

All investing is subject to risk, including the possible loss of the money you invest. Investments in target-date funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the work force. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in the target-date fund is not guaranteed at any time, including on or after the target date.

IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time.

The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.

The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.

© 2017 The Vanguard Group, Inc. All rights reserved.

Important information

target-date funds laying a critical foundation for ... · actual investment results, and are not...

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