The Rise of Alternatives in Target Date Funds 

Target Date Funds (TDFs) entered the Canadian market in 2005, offering defined contribution (DC) plan members a simplified investment approach in which the fund manager handles ongoing asset allocation decisions. Since then, both target date funds and the DC market have evolved.

Today, more individuals are now relying on a DC plan for their future retirement. At the same time, rising costs have made inflation a greater concern for those nearing retirement. Longer life expectancies have also increased the risk of outliving savings.  As the landscape changes, TDF portfolios have moved beyond traditional exposure to just public equities and bonds. 

Alternative investments generally refers to non-traditional asset classes such as real estate, infrastructure and private markets. Alternatives can be used to enhance returns, to manage risks or to improve diversification. 

Today, it is common for target date funds to include some form of exposure to alternatives whether directly or through listed securities.

The number of TDF managers investing directly in alternatives has grown (some of the underlying direct alternatives funds may also hold liquid assets). Most managers now include listed alternative fund components in combination with direct alternative fund components. Real estate, infrastructure and commodities are the most prevalent types of alternatives used.

Some alternative assets are less liquid. Under a DC plan, liquidity is essential to accommodate regular cash inflows and outflows. Fees associated with alternative investments are often much higher compared to traditional asset classes. This needs to be weighed against the pressure to maintain competitive overall TDF fees. 

As TDF managers are determining how to integrate alternatives in their portfolios, operational considerations need be factored alongside investment benefits when modeling and stress-testing different scenarios. To address these challenges, TDF managers may limit portfolio exposure to alternatives or incorporate liquidity sleeves in the underlying alternatives fund.