Target date funds (TDF), renamed “Fondos Generacionales”, Generational Funds (GF) by Consar, the Mexican regulator, involve more qualities than the Siefores Básicas (SB), those restricted regime pension funds. As is known, in the United States, TDF are considered for the "401 (k)" pension plans, as one, not the only one, of the good products to be chosen by the employees, who decide how to invest their savings.
To gauge how important they have become, we can see their weight in the balance of the accounts: 20% at the end of 2016, according to www.ici.org. It should be considered that they are the investment by default, the fate that is given to the money of those who do not choose any product, and that were enthusiastically promoted by the Obama administration.
How do the TDF work? What will the GF be like?
TDF are funds of funds to balance risk and return. At the beginning of the working life, when the employees are young, portfolios are 100% invested in equity (“E”) under the premise that, the younger, the more tolerance to risk and more time to recover from debacles. TDF point to a defined year, which usually carry by name, for example, Vanguard Target Retirement 2040 Fund, “VFORX”, for workers to retire between 2038 and 2042. Halfway through the cycle its composition reveals the pendulum or sense: the equilibrium of risks: 83% in “E” (index funds with more than 10,000 shares) and 17% bond funds (“FI”).
The GF of Mexican Pension System (SAR) will invest directly in equity, bonds and other assets. Its non-mandatory cap of “E” will be 60%. By adding structured assets (“SA”) and local Reits (“R”) could reach 90% in high risk. Yes, the non-mandatory nature means GF could be composed just with “FI” assets, 100%, all the time. New funds will be identified by the range of years –properly, the “generation” – in which the workers were born; for example, “Sociedad de Inversión Básica 75-79”, for contemporaries of the Americans of the 2040 target.
In a simple way: instead of moving the employee by age in a staggered way from SB4 to SB1, from higher to lower risk (from 45% to 10% maximum in “E”), his only GF will be the one that adjusts the equity parameters, from maximum of 60 % to limit of 15%, according to its productive stage.
What is the disputable of the TDF?
- The large load on risk assets, potentially the most profitable, is carried out over low balances. As the balance swells the load falls. Thus, the higher profitability is expected on sums that influence little to increase the savings. Several studies reveal that if the percentage of risk is not altered or if it is increased gradually (contrary to what is intended), better results are achieved.
- The analysis and exercises of Javier Estrada ("The Glidepath Illusion: An International Perspective", 2013) are enlightening: “simple alternatives… contrarian, equity-driven, and balanced strategies… provide investors with higher expected wealth at retirement and generally higher upside potential, than lifecycle strategies”. The uncertainty, concludes the meticulous Estrada, is “…about how much better, not how much worse, investors are expected to fare with these alternative strategies”.
“Generational Funds” of SAR: more controversial than TDF
- Observations on the incidence of “E” and “FI” in TDF will apply to GF. The optional cap of 60%, without considering “SA” and “R”, of slow maturation, will influence a meager balance, given by few weeks of history and small/medium contributions; meanwhile, the “FI” will apply on a large balance, the result of years of accumulation and substantial contributions for higher salary, and consequently will weigh much more.
- Those who are going to retire around 2040 could today have up to 30% of "E" in SB2. As of December of this year they could have 53% to 47% (without “SA” or “R”), if the Afores exploit the permitted ceiling, which seems difficult, considering the evolution of the system's investments. Meanwhile, their US counterparts assume 83% of pure “E” with VFORX, and 66% broadly and weighted, according to 401 (k) *.
- What remains unchanged: Investment in “E” and other highly risky assets will continue to be optional, contrary to the sense of the TDF and differentiated from Chilean pension funds that maintain high mandatory minimums.
- See that Mexican pension system's exposure to risky assets in May (“E” + “SA” + “R”) was 26.4%; that of SB4, the riskier, 33%. On the other hand, to March, the equity of the Chilean pension funds was 39.4%; that of the riskier, "A" fund, 80%.
The maximum historical proportion of SAR in “E” did not exceed 25%; that of SB4, of 34%. The one of “F” does not raise, that of Commodities was only to appear (see “Las adecuaciones al régimen del SAR no han generado cambios sustanciales en las inversiones de las Siefores”). It remains to be seen how much of the new regime the managers exploit. Is it possible that some will also maintain minority portions of “E” in the new “GF”?
Column by Arturo Rueda
** Calculated with the equity composition of VFORX and data from the table "Average Asset Allocation of 401(k) Plan Accounts. 2016”: [(83% x 11.90%) + 43.10% + 6.50%] = 66.07%