The OnTarget Index(es) are distinct from other indexes and from other target date funds in a number of ways.

The OnTarget Index, a series of benchmark indexes for target date funds, is the standard for prudent target date fund design. It is the only “TO” target date fund index in the industry.

OTI Objectives
1. Safety—Preserving value is our primary goal.
2. Performance—Growing value is our secondary goal.

OTI Policies
• Diversification
• Risk Control
• Sound Theory

You might also say that the OTI has been successful relative to other target date indexes and funds because we stick to our core objectives; we don’t try to force the OTI to serve diverse and conflicting objectives. A portfolio model cannot simultaneously serve two dates, the target date and another date fifteen or thirty years further out. The OTI recognize the difference between the accumulation phase and the decumulation phase in the life cycle of investing.

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We began with Modern Portfolio Theory concepts, in particular the Capital Market Line. This line theorizes that the best mix of risky assets is the world market portfolio (WMP), comprising all assets in the world in their market weights, and that combining the WMP with a “riskless” asset dominates the efficient frontier, providing more return per unit of risk. Accordingly, we use a two-asset model: the WMP and a riskless asset. The riskless asset is designed to maintain purchasing power, i.e., to protect against inflation as well as potential nominal losses of the risky asset.

The next step was establishing the glidepath, which is based on liability-driven investing (LDI). The point at which we start to apply the brakes is the longest time period over which we estimate that there is a possibility of loss in a well-diversified portfolio. Prior to this protection date, we are invested 100% in the WMP. At protection outset we calculate the amount that needs to be sheltered in reserve to assure that even if the worst-case loss occurs, the purchasing power of the current assets will be preserved. We use a “lockbox” for the reserve, which means that once assets are committed they cannot be withdrawn. As the target date draws near, a greater percentage of assets are committed to reserve (or to the lockbox) to protect against worst-case losses until, at the target date, nearly all assets are in reserve. This describes our signature Index.

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If you follow Modern Portfolio Theory concepts in its most theoretically sound and pragmatically tested forms, you are inexorably drawn to the Capital Market Line. This line represents the most efficient combination or “best mix” of two assets: (1) a risky asset, the world market portfolio (WMP), comprising all assets in the world in their market weights, and (2) a riskless asset. The riskless asset is often represented by Treasury bills, but other forms of riskless securities can be used. The resultant line dominates the efficient frontier, providing more return per unit of risk. Accordingly, we use a two-asset model: the WMP and a riskless asset. The risky asset serves the function of providing for portfolio growth. The riskless asset is designed to maintain purchasing power, i.e., to protect against inflation as well as potential nominal losses of the risky asset.

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The “lockbox” we reference is simply a methodological process we undertake to ensure that those allocations to the reserve or “riskless” asset are committed to that asset. It is a one-way allocation; assets that go into the riskless asset never come out to replenish losses in the risky asset. As the target date draws near, a greater percentage of the assets are committed to the reserve asset (or “lockbox”) to protect against worst-case losses until, at the target date, nearly all assets are in reserve.

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We believe investors have a different set of decisions in the accumulation phase than in the distribution phase, and that reliable benchmarking tools can be provided for the accumulation phase, but not for the decumulation phase. The likely uses of the funds at target date and beyond are so divergent as to render any attempt to find a single optimum strategy for all investors (and consequently any attempt to benchmark those strategies) futile. Because of the divergent investor needs at the target date, we think maximizing liquidity at target date allows all users (and their providers, advisors, etc.) to adopt their own prudent strategies. We do not stop there, however. The current development of a broad array of retirement income products is the appropriate response to a market need. We fully expect that more specific and advanced retirement income products, including a variety of annuity designs, will come to market over the coming months. In short, the needs for the accumulation phase and the decumulation phase probably cannot be well addressed by a single series of target date funds.

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It is true that an investor with a 100% fixed income allocation over their entire accumulation phase will likely underperform a portfolio that includes some equity. Our concerns are with excessive amounts of equity in the years just before, at and after the target date. No one seriously challenges the fact that higher equity amounts carry higher risk. Risk means the possibility of loss. In the short timeframe that we’ve been tracking performance (more or less 100 years), there are periods as long as 20 years in which equities have experienced negative returns. Some advisors naively assume that if the chance of gain is higher than the chance of loss that that’s a bet worth taking, but such a bet is counter to the fiduciary responsibility of a plan sponsor and its advisors to protect the hard-won assets of all plan participants. We believe that duty is (1) to preserve the assets of the greatest possible number of participants and (2) to provide for growth without violating #1.

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They stack up quite well. Please review the performance of the OnTarget Current Index. (“Current” meaning the target date has been reached or that the portfolio is designed to serve investors in the retirement years rather than the accumulation phase.)

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It is important to remember that regular withdrawals compound the volatility we call market risk, and a portfolio in withdrawal (in the decumulation phase) must be primarily positioned to preserve principal with a very low allowance for loss. Undoubtedly, many participants will reach their retirement with inadequate balances, but that problem cannot be solved with an aggressive allocation solution.

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The effective and specific way of dealing with inflation is with TIPS. For that reason we include a substantial allocation of TIPS in our “Reserve Assets.” We assume investors will use their account balance at target date to fund their distribution phase. This funding may be through the purchase of annuity, or an allocation designed specifically to provide income and preservation of principal. Asset growth is no longer the primary concern, as it is in the accumulation phase.

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We've done considerable back-testing. The geometric glidepath ensures against worst-case loss by design. As risk increases geometrically in the latter years of the accumulation phase, the risk protection increases as well.

Moreover, we have undertaken (and are working on even more) considerable testing of existing funds to separate out the benefits (alpha) of a specific fund company’s asset mix from the benefits (alpha) of its glidepath. These measures are benchmarked against the appropriate OnTarget Index.

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