September 11, 2025

Episode 374: David C. Brown - The Underperformance of Target Date Funds

September 11, 2025

Dr. David C. Brown is an Associate Professor of Finance and the Brian and Clara Franke Endowed Chair in Finance in the Eller College of Management at the University of Arizona. David's research has been published in the Review of Financial Studies, the Journal of Financial Economics, the Review of Finance, among others, and was recognized with the 2018 TIAA Paul A. Samuelson Award for Outstanding Scholarly Writing on Lifelong Financial Security.

His research has been featured by the Wall Street Journal, Bloomberg, Forbes, Consumer Reports, Money Digest and ValueWalk. David teaches financial modeling at the graduate and undergraduate levels, has been ranked in the top 10 in the world in Microsoft Excel and Financial Modeling World Championships, and has been featured multiple times in Excel Esports on ESPN. He is the founder of the Microsoft Excel Collegiate Challenge and a Microsoft Excel MVP.

In this episode, we’re joined by David C. Brown, Associate Professor of Finance at the University of Arizona, for a deep dive into the mechanics, performance, and pitfalls of target date funds (TDFs)—the most common investment vehicle in U.S. retirement accounts. David has spent years researching glide paths, benchmarking methods, and industry practices to uncover whether these “set it and forget it” funds actually serve investors well. We unpack why benchmarking TDFs is so difficult, what really drives their underperformance, and how tactical deviations from strategic glide paths often harm investors. David explains how fees, active management, and fund structure combine to create persistent drag—and why dispersion across TDF providers is shockingly wide. We also discuss behavioral challenges, the influence of glide path design, and whether innovations like “indexing the indexers” could improve outcomes. David also shares insights on his side project, the Microsoft Excel Collegiate Challenge, where students compete in gamified problem-solving competitions (yes, Excel on ESPN!), and reflects on his own definition of success. This conversation sheds light on a massively important—but often misunderstood—corner of the retirement landscape, giving investors and plan sponsors practical tools to demand better.

Key Points From This Episode:

(0:05:20) What a Qualified Default Investment Alternative (QDIA) is and why TDFs became the default in 2006.

(0:05:50) How target date funds work as “one-stop shops” for retirement savings.

(0:07:12) The glide path concept: why equity allocations decrease with age.

(0:08:04) Why comparing TDFs is hard—fund families design glide paths differently.

(0:10:37) David’s benchmarking approach: replicating TDFs with index funds.

(0:15:13) The performance gap: ~1% annual underperformance versus replicating benchmarks.
(0:15:50) Main culprits: higher fees (~55 bps) and poor active management (~45 bps).

(0:18:20) Good news: costs have declined—but dispersion across providers remains massive.

(0:20:09) Evidence of wild return differences: up to 23% in a single month across vintages

(0:21:32) Why plan sponsors and investors aren’t reacting to poor performance.

(0:25:33) The debate over optimal glide paths—and why the jury is still out.

(0:29:15) Tactical deviations: managers shifting allocations beyond the strategic design.

(0:33:06) These tactical moves hurt performance (~10 bps on average).

(0:35:49) Evidence of return chasing in TDF management.

(0:39:07) Big picture: TDFs are a huge improvement over money market defaults, but dispersion and inefficiency remain.

(0:42:48) David’s views on Scott Cederburg’s 100% equity lifecycle portfolio research.

(0:45:22) Behavioral challenges: why defaults and illiquidity may help investors stay the course.

(0:50:57) The Microsoft Excel Collegiate Challenge—Excel as an esport.

(0:52:50) How David defines success: balance, impact, and growth.

Read The Transcript:

Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians. We're hosted by me, Benjamin Felix, Chief Investment Officer and Cameron Passmore, Chief Executive Officer at PWL Capital.

Cameron Passmore: Welcome to episode 374 and Ben, shout out to you for finding another phenomenal guest. This week, we head back to the University of Arizona. We had a great chat with Professor David C. Brown. What a fascinating, nice guy. You see that there's stylistic commonalities with his colleague, Scott Cederburg, who is a fan favorite on the pod.

This week, the topic is about glide path and target date funds in retirement accounts, predominantly in the US. It's not as predominant in Canada, but the concept is you have an asset allocation that drifts to become more conservative as you get older. Wow.

The stuff that we learned today, I know you've done a lot of research. You have a big head start on me. It is absolutely fascinating.

It goes into areas that you never even saw coming. With that, you have to tee this one up.

Ben Felix: We talked about David's research on target date funds, which he's spent a lot of time modeling and thinking about and benchmarking. Target date funds are super common in US retirement accounts. A lot of people participate in 401k plans.

As David mentioned, a huge portion of the contributions going into those 401k plans.

Cameron Passmore: 70%.

Ben Felix: That's right.

They're going into target date funds at this point in time. They're enormously important to American retirement savers. Scott's research, just to come back to that, we do discuss that with David in the episode as well.

Scott's research basically suggests that target date fund asset allocations that drift toward fixed income over time may be suboptimal. They should probably have, in Scott's paper, 100% equity allocation all the way through, including right through retirement. That shows that maybe their asset allocations are suboptimal.

Then what David's research shows is given the asset allocation that a target date fund has, how are they performing? They built a methodology for benchmarking target date funds that holds their asset allocation and their glide path constant, but asks in very simple terms, how would this glide path have performed if it were simply invested in index funds instead of invested in the actual funds that make up the target date fund? I don't want to spill the candy in the lobby as you say, Cameron, but they basically find that target date funds are not performing very well relative to that index fund implementation of the same glide path.

That's a whole other interesting idea. We talked about the dispersion in target date fund returns as well. I find it really interesting that if you're in a retirement plan and you're investing in a target date fund, you kind of assume, and I kind of had assumed because target date funds, as you mentioned, Cameron, they're not as big in Canada.

I haven't looked at them much, but I kind of just thought a target date fund is a target date fund. That could not be further from the truth. You can have materially different asset allocation glide paths and materially different returns from one target date fund to another.

Cameron Passmore: And materially different rebalancing.

Ben Felix: Also true.

Cameron Passmore: This human behavior element kicks in when you would think this is like the rules cast in stone type plans. That is not the case necessarily.

Ben Felix: They documented some of the research that we talk about that target date funds appear to be tactically deviating from their strategic asset allocation glide paths, which contributes to the dispersion that we see in target date fund returns. It really is wild. A lot of interesting stuff to think about for anyone who's investing in target date funds and assuming like I did, that it's designed to be the default option.

You just kind of assume that a target date fund is a target date fund. I think you have to really look more carefully and that's part of David's motivation for this research is to help people, give you the tools to look more carefully at what is actually happening under the hood with their target date fund. I think it's a really interesting discussion.

I think the research that they've done is pretty compelling. We will link to the tool that David and his co-author Sean Davies have built that lets you look under the hood of American target date funds. Lots of good stuff to think about I think in this episode.

We have heard from listeners who have based on rational reminder content gone to their HR department or whatever and have actually successfully argued for changes in their company 401k plan options. This will contribute to that type of discussion.

Cameron Passmore: David C. Brown is the Associate Professor of Finance at the Eller College of Management at the University of Arizona.

Ben Felix: I think that's a pretty good introduction.

Cameron Passmore: And a good guy, very compelling. With that, let's go to our conversation with Professor David C. Brown.

Ben Felix: David Brown, welcome to the Rational Reminder Podcast.

David C. Brown: Thank you so much for having me. Really appreciate being here today.

Ben Felix: We're excited to be talking to you. To give us some background, can you tell us what a QDIA is?

David C. Brown: It's a Qualified Default Investment Alternative. What that really means though is it can be included on a retirement plan menu as the default. Many people when they sign up, have no idea what to select.

You have to give them something. That menu is part of the Pension Protection Act of 2006 expanded to include target date funds. That's a lot of the reason we're talking today is because of that expansion they did in 2006.

Ben Felix: And just to make sure listeners are on the same page, what is a target date fund?

David C. Brown: A target date fund is basically a one-stop shop for investors that are planning for their retirements. There are all sorts of different asset classes that investors might want to have as they save for retirement. A target date fund is designed to do that asset allocation for you.

It'll do your mix of stocks and bonds. It'll actually change to evolve over time. If you're retiring in 2060, you can buy a 2060 retirement target date fund to basically fund your retirement.

Then every month, you're just putting money into that same fund and the fund's taking care of the asset allocation for you.

Cameron Passmore: How significant are target date fund holdings in American retirement accounts today?

David C. Brown: Increasingly more and more so. I think there are about half of retirement accounts now that's been increasing over time. But I think the big number to look at is on a monthly basis as people are contributing, over 70% of the money is going into target date funds now. It's really significant.

If you look at younger people, people that started with them as the default options, most if not all of their assets are in a single target date fund, which is exactly how the product was designed. So, it's doing what we wanted it to do. But it also means these target date funds are having an increasingly important space in the retirement landscape.

Ben Felix: Can you talk in general terms, you mentioned that they changed the mix of stocks and bonds over time. What does that glide path typically look like?

David C. Brown: The idea of a glide path is that you're going to decrease the amount of risk you take over time. You might start out 20 years old in your first job saving into your retirement plan and almost entirely invested in stock with this whole idea of stocks for the long run. There's all sorts of lifecycle portfolio choice models built around this.

And the vast majority of them kind of indicate you should take more risk early on because you have a lot of human capital in your own income you produce. As you get older and you have less time to work yourself, you shift into safer assets like bonds. Obviously, there are lots of counterpoints that come in on that.

But I think that's the generally accepted wisdom today. So, you're going to see that mechanical decrease in equity exposure or risk as you age and get closer to retirement.

Cameron Passmore: Why is it difficult to benchmark or even compare target date funds?

David C. Brown: Because they all do it a little bit differently. Each of the different target date fund providers and here you think Fidelity, PIMCO, T. Rowe Price, Vanguard, they all have all sorts of different choices they can make.

One choice is what does that glide path look like? How much equity do you start with? And then how quickly do you decrease that equity mix over time?

So, that's going to be one big choice. Another big choice is going to be, well, within the equity bucket, how do you slice that up? Do you do a mixed domestic and international?

And then if you do domestic and international, do you do more subasset classes? So, do we start doing small, medium, large value and growth all within the US and then outside the US start about developed versus emerging markets? Or do we split developed markets into Asia, Pacific and Europe?

You can go kind of on and on. And what you'll see is that some fund companies decide to put 30 different mutual funds in their target date fund. Others tend to do four.

So, there's vast diversity in how that is accomplished. And then as one more, how are you going to manage that glide path through retirement? This is one of the classic ones is the two versus through retirement, because two retirement almost assumes that once you hit 2060 or 2025 for those retiring this year, the idea was that you would take your money out.

Well, fund managers don't like the idea of losing their assets under management. And so then through retirement plans came out. And so the idea is that they're going to continue managing that asset allocation mix all the way through your retirement.

So, you invest in this when you're 20 and you hold this thing until you die, basically. That's kind of the asset management industry's plan on it.

Ben Felix: We don't have a big target date fund market in Canada. They did not develop in the same way that it has in the States. So, I hadn't thought a ton about it, but just the fact that they have different glide paths and the fund companies will even try and differentiate themselves by having a better glide path.

It's super interesting. I didn't really realize any of that.

David C. Brown: One other layer is that the fund companies almost exclusively hold their own funds. So, it's not like Fidelity is looking outside of Fidelity for mutual funds to hold. They're pretty much looking exclusively at Fidelity funds.

So is Vanguard, so is PIMCO, so is BlackRock. All the big players do this and there are very few that will actually deviate and try to pick the best funds from different fund families. As a result, you end up with a beholden fund structure where you have to use Fidelity funds if you're in the Fidelity plan.

Ben Felix: How do you approach benchmarking target date funds in your research?

David C. Brown: What we found when we started looking at this is there's no great benchmark. Part of it is because of these different asset allocations, different funds. I didn't even go into different fee structures, but it all makes it very hard to compare.

Our premise, these are funds of funds. They're holding other mutual funds in them for the most part. So, what we can do is look at those underlying mutual funds and map them to a common set of assets.

I mentioned US equities versus international equities or large cap versus small cap. We have a pretty good way to benchmark those funds and those are index funds. This has been a big part of the literature of comparing active to passive management for a long time.

And so our basic idea is if we can take any given fund that a target date fund holds, map it to an index fund that it best replicates, we're going to think about replicating funds here, then we can take those underlying passive index components, build them back up into the same portfolio with the same asset allocation. And now we have a replicating target date fund. So, essentially it's a custom benchmark built to each individual TDF.

If you were to make that TDF as a passive product.

Ben Felix: So, it's taking the glide path of the asset allocation as given and then comparing the underlying funds to index funds rolled up to the asset allocation.

David C. Brown: Exactly. You can think about it as measuring the operational efficiency of the target date fund. We're taking the glide path as given and we can talk more about that as we keep going because that necessarily means that some of the value that these TDF managers are adding, we're not giving them credit for here.

We're just saying, given that you picked your asset allocation, how well did you basically deliver on it relative to what you could do with a very cheap passive product?

Ben Felix: How confident are you that the replicating ETFs that you're choosing or index funds that you're choosing are actually good representations of the underlying asset class funds in the target date funds?

David C. Brown: Overall, I'm very confident at the TDF level. And that's because we can run regressions and correlations and look at how well do those replicating fund returns match the TDF returns. On average, it's 99.7% kind of match. Oftentimes it's 99.9. But we do get situations where the match is not great. You could think about, for example, a commodities fund. In our first iteration, kind of our baseline specification in the paper, we match all the underlying funds to a set of Vanguard index funds and ETFs.

So, we use both index funds and ETFs. That way we show it can work either way. But it's really just 50 funds.

And in that mix, Vanguard did not have a commodity fund at the time. As a result, you can get a commodity fund that Fidelity is offering that really doesn't match very well to anything. This example, I think we had like a 60% correlation or a 0.6 correlation rather. And so the match is not great. However, commodities are usually a very slice of the portfolio. So, when you aggregate that up, really it washes out at the end of the day.

That's not a perfect answer. So, what we actually do is kind of an extension is we say, let's just take the entire ETF universe so that you can use any ETF to match this to because there's pretty much an ETF for any asset class. We get much better individual matches and the overall results of the paper do not change at all.

At the end of the day, we don't think it's something that matters significantly as we get the whole feeling of the industry.

Cameron Passmore: How much tracking error do your replicating funds have relative to the target date funds?

David C. Brown: For the most part, it's very, very minimal. These things are tracking 99.9%, 99.7. We do see some interesting differences come up though, that we had to address in the research. One of those is that when you build up a replicating fund, you're not going to have the same cash drag that a target date portfolio has to do.

The fact that they have money flowing in and out through redemptions and new money coming in, they have to keep some cash on hand to manage that. Oftentimes it's two or 3% of the portfolio. If we don't replicate that cash piece, then we're going to actually have better returns when markets are up.

You just have more risk exposure and less when markets are down. We get basically a little bit more beta in ours than we would get otherwise. Again, we can adjust for that when we're doing the analysis.

Ben Felix: Do you adjust for that? Do you add a cash allocation?

David C. Brown: We do two different types of analysis here. One, we do it with replicating funds and there we don't add the cash piece. We also do the more traditional beta and alpha type asset pricing analysis and that's where we account for it with that beta piece.

Ben Felix: How do the target date funds perform relative to the replicating benchmarks?

David C. Brown: This is all in the original paper we wrote that ended in 2019 for our sample. It was about 1% per year is how much they underperform these replicating fund benchmarks. 1% a year, I think most of the listeners here understand that that's a big deal, but especially it's a big deal when you're thinking about retirement horizons.

If you're 40 years out from retirement and you're thinking about maybe 20 or 30 years in retirement, 1% a year for 60 or 70 years is half your money. It's a really significant amount that we're talking about here.

Cameron Passmore: What are the main drivers of this underperformance?

David C. Brown: There are two big drivers and one small driver. The biggest driver is fees. There's no surprise here for that 1%, about 55 basis points of that is higher fees on the TDFs. These are incremental fees.

The replicating fund itself has index fund fees built into it, so it's fees over and above that. Those are really coming from two sources. One is the underlying mutual funds.

Many times they are active and so they're just going to have higher fees. Just focusing on the fee piece is going to pick that up. The other piece is TDF level fees.

These are funds of funds and so the TDF will also charge a fee on top of the underlying funds management fee. Now, that's not always the case. Some funds will charge no TDF fee, some will charge no fee on the underlying assets, so they'll use zero cost share classes.

That's another way that I think the TDF companies play this game a little bit of how they present their fees. At the end of the day, 55 basis points is from that fee piece. Now, the other 45 basis points, that's coming from poor active management.

If we just look at gross returns, so take the fees out of it now, the active funds underperform those passive benchmarks by that 45 basis points on average per year. That's before fees. We want to find active managers that are actually at least breaking even and covering their expenses, but those are not the funds that have traditionally been placed in targeted funds.

Ben Felix: Wild. So, they're underperforming gross fees and then obviously even more so net fees.

David C. Brown: Exactly. Then there's a small third piece that is timing. When we're doing our analysis, this is all based on the holdings that the funds report.

The TDF reports their holdings at the end of each quarter. What they do between the quarter, we can't really see. They're making tactical asset allocation decisions.

They're rebalancing. Ultimately, we have to choose a benchmark here and we choose to rebalance monthly. We're going to update the holdings quarterly.

The extent that they're rebalancing differently than that and they're also making shifts in the asset allocation that we don't see, that can either add or subtract value as well. On average, that's about a couple basis points per year. So, not really significant one way or the other.

Ben Felix: It's really the underperformance of active and then add on the higher fees.

David C. Brown: Exactly.

Ben Felix: Not surprising, I guess, but not good news for target date fund investors.

How have those costs evolved? How do they evolve over your sample period? Are costs getting lower or is it improving?

David C. Brown: I guess there's good news and bad news. The good news is that the cost of TDFs have come down quite a bit over time, just like we've seen in the passive fund space and the active fund space for that matter. Whereas on average, I think the average fee a decade ago is like 60 basis points-ish.

Now it's down into the 40 basis points range. It's certainly improving. However, it's not necessarily all getting better.

We don't have a current number on the recent decade, just since we haven't updated the academic paper. But this actually brings me to something that my co-author and I have done. And that's that we think it's really important for investors to have access to this kind of data on their fund.

As academics, we do research with data that we all kind of get from a university license and we can't take that data and put it on a website somewhere. My partner and I, Sean Davies is my co-author at Colorado. We actually started a company where we're able to buy the data to provide it to people.

The website is glidepathfinancial.com. But you can go there and basically look up whatever your TDF is and see how it's performed over the last five years. Good news again is that a lot of funds are doing well and generally that spread has come down.

The bad news is there's still a huge disparity between the best and worst performers. If you look at BlackRock over the last few years has done really well and oftentimes they'll beat their benchmark by sometimes more than a percent. On the flip side, we have TRO or American funds that are lagging it by more than a percent.

You can see 3% difference in relative performance from the best to the worst performers, which we talked about 1% being big, 3% is massive.

Ben Felix: That's nuts. There's very, very significant dispersion between given a retirement date, if I understand correctly, the best and worst target date fund performance is materially different.

David C. Brown: Yeah. Balduzzi and Reuter, they have a 2019 paper in the RFS that looked at this first document at how much dispersion there was. Obviously, this is cherry-picked, but there was one month in which if you compared TDFs within a given vintage, the difference in the monthly return, one month return between the best and worst performers was 23%.

Ben Felix: Yeah, that's nuts.

David C. Brown: Dumbfoundingly huge. Because they're taking against so many different kinds of bets in different ways, there's a lot of scope for this dispersion and performance that really hasn't gone away over time.

Ben Felix: Wild, yeah. That's like a whole other risk for target date fund investors. On average, you've got the drag, but you could end up in one of the worst performing target date funds, or I guess one of the best ones.

David C. Brown: Right. I was mentioning some companies here. When we wrote the original paper, Fidelity, they were an underperformer by about a percent per year.

If you look in the last five years, they're overperforming by about a half percent per year. This is kind of averaged over vintages and different time periods. Fidelity is a fairly active shop, and that's where a lot of their outperformance is showing up.

So, for a good period of time, they underperformed. Now they seem to be overperforming based on this type of benchmarking. What are they going to do for the next 60 years?

Who knows? But that kind of volatility is something that you're going to get when you have more of this active management.

Cameron Passmore: And do you find any evidence that the plan sponsors or investors are aware of how their target date funds are actually doing?

David C. Brown: Not really. The way we approach this is to look at fund flows or the assets under management. This is a traditional approach in the academic literature that we can say, when a fund does better, it tends to attract more inflows.

More people want to invest with a manager who's producing alpha. And so we can say, all right, when the TDFs do better, based on this measure, relative to this benchmark, do they attract more money or do they lose more money when they do worse? And generally, there's no sensitivity to it from investors.

I think you hit on this, Cameron, but it's not really the investors that always have the choice. You're in a 401k plan where most of these assets are. You really only have access to one TDF.

You might have access to different vintages. So, you can pick whether you're in the 2025, 2030, 2040, et cetera, but you're not going to have a Fidelity and a Vanguard product right next to each other, at least not very often. If you're going to change, it's usually somebody in your HR department that has to start that process going forward or a plan sponsor that's going to go ahead and say, okay, we're going to shift everyone from sponsor X to plan X to plan Y.

Even there though, we don't see a lot of evidence that those big shifts are happening in response to this performance.

Ben Felix: Interesting. It's not the individuals, it's the plan sponsor that have to make the change, but it doesn't seem like they're following your benchmarking methodology to say, hey, maybe we should change fund providers.

David C. Brown: And I think a lot of that's because this is not trivial analysis to put together. It takes a bunch of academic analysis to be able to understand how should we construct these portfolios, actually do it, and then try to make it available so people can make decisions off of it. Too often in academia, we're very much in our ivory tower of let's figure it out and then we'll tell the other academics about it through our finance journals.

But we need ways to disseminate it and push it out to practitioners who can make decisions based on this data now. That's why we have our website.

Ben Felix: I want to come back to the benchmarking methodology and how it holds the glide path constant. What do you think about the argument that an actively managed fund family, like say it's Fidelity or whatever, with a better glide path, I was actually reading some Fidelity TDF literature recently, and they talk about their belief that investors should have higher allocations to equities. Fidelity said, "okay, we need a higher equity allocation."

I know you said that they're outperforming based on your methodology, but even if they're underperforming relative to an asset allocation held constant benchmark, they might be outperforming relative to a more conservative target date fund. How do you think about that?

David C. Brown: The first step is that we don't have to think about active glide paths as necessarily being active underlying funds. Fidelity offers a number of products. You could go to Fidelity and use their Fidelity Freedom Index product, which is going to be just index funds.

You can go Fidelity Freedom, which is the active funds, or you can go Fidelity Freedom Balanced, which is going to be a mix of the two. You can make these two decisions independently, basically. You can pick your risk level through the fund family, and then pick whether you want the active or passive implementation of that glide path.

It's not really a fair choice to say those are necessarily coupled. That said, it could be that active fund managers, some TDFs are actually more active in managing their glide paths than others, and we'll get to that in a minute. The other big consideration is that we really don't know what an optimal glide path looks like.

In the academic literature, there's general consensus that it should be downward sloping, so less risk over time, but some people have proposed it could actually be upward sloping. One of my colleagues here at the University of Arizona, who's been on your show recently, argues for essentially an all-equity retirement portfolio split between domestic and international funds because of some long-term return properties. It's a fascinating paper by Scott Cederburg and co-authors.

Essentially, the jury is still out on what the optimal glide path is. While you might think you want a riskier glide path, sure, you can go for that. You can clearly see some are going to have more risk than others.

Again, I think that can be separated out from how active your manager is at the end of the day.

Ben Felix: Like you said, we don't know what the optimal glide path is, so it's a bit of a tricky question to ask. If we believe that a higher equity allocation is good, as Fidelity suggests it is, and as Scott Cederburg's research suggests that it is, what do you think about the argument that the active management in Fidelity's active target date fund actually allows the plan participants to feel more comfortable with a higher equity allocation? It's like the Money Doctor's paper in General Finance where even if it's not working, the end investors trust that the active managers are doing something good for them that allows them to take more equity risk and that's not a good thing. What do you think about that?

David C. Brown: I think there's definitely something to be said for that. There are all sorts of behavioral considerations that have to be accounted for when thinking about target date funds because these are people making real decisions, not in a vacuum of an academic model. That said, with the Money Doctor's perspective, the assumption is you're working with somebody that you can trust and you can develop that relationship.

In these cases, somebody's picking a plan off of a menu in a 401k and they have no idea whether there's a person doing anything in the background there, so I'm not sure how much it really matters in this setting. There's a small slice of investors who access TDFs directly through a financial advisor, but if you're going through a financial advisor, odds are that they're going to be more actively managing your portfolio or at least managing the asset allocation more than just putting you in a plain vanilla TDF. They could, hopefully they're not charging you too much if that's the piece they're doing there.

Ben Felix: I don't love that argument about active management allowing people to take more equity risk. We, on this podcast, typically advocate for index funds, but it is a comment that I've heard with respect to target date funds. Like, yeah, active management might underperform, but it's going to let people feel more comfortable with more equity risk, therefore it could be actually a good thing.

Your comments made a lot of sense.

Cameron Passmore: So, in designing an alternative solution, how would you address the dispersion in glide paths across TDF fund families?

David C. Brown: You have all these different TDF families that have big research teams that they've employed to design these optimal glide paths, so we have a lot of different people arguing over this. Again, it's fascinating how distinct these glide paths can be. Again, they're generally downward sloping, but they change frequently and they can have very different slopes and they're all over the place.

So, my perspective on this is we have a bunch of people, let's use the wisdom of the crowds. This has come up in lots of other contexts and shown to work well. So essentially, if you take the industry aggregate asset allocation and use that as a way to drive a TDF, I think that could actually be a very valuable product and that essentially you're indexing the indexers almost.

You're taking the index fund idea to an asset allocation level rather than to an individual asset class level, which has been what's been very successful up to this point.

Ben Felix: That's a super interesting idea. Do you asset weight that or just equal weight the allocations of other target date funds?

David C. Brown: I think there are a lot of questions on how you want to do it. The first level question is, do you give Vanguard 40% of the weight? Vanguard is a very particular asset allocation.

They use four to six funds rather than many of the sub-asset allocations. They're just going very high level. They have 40% of the assets.

They're generally on the conservative side. That's where some careful thought can be put into it. We actually might see multiple index providers come out with something like this that all have a different flavor to them.

Because the other big question is how quickly do you rack to the industry? Because like we'll talk about in a minute, some of these funds are changing their glide paths very frequently. Do you necessarily want to be chasing these quick changes in asset allocation if you're more of a stable long-term index type idea?

Ben Felix: Yeah, especially given that those tactical changes are not doing so hot. Can you keep going on? How often do target date funds tactically deviate from their glide path designs?

David C. Brown: Before I get too deep in this, I want to talk about the glide path design and what we can do and what we can't do. Glide paths are something that we can observe from time to time. That's essentially what we do each quarter.

We see the asset allocation and we see it across different vintages within a TDF series. A TDF series will have a 2025, a 2030, a 2035, all the way out to 2070. I think there might be a 2075 on the market now, but there aren't many of them.

You can essentially piece together the glide path by seeing how that asset allocation changes at one point in time across the different vintages. Is that their intended glide path? Not necessarily.

They oftentimes put a graph in their prospectus that comes out once a year that shows here's our glide path, but they also say we can deviate from that. Oftentimes that picture doesn't change much from year to year, even if their asset allocation did change from year to year. What they're intending to do in their glide path is very different than what we can capture.

What we can capture is just how did the asset allocation change. When we look at how did the asset allocation change, and we can do that relative to how we expected it to evolve along the glide path, we see that from one quarter to the next, they're changing their glide paths by about 4%. What that means is say you just had a two-asset portfolio, stocks and bonds, 50-50.

That means by the end of the quarter, you've gone to 54-46. That's a pretty big shift. If you go out a year from that initial point where you measured it, now it's 9%.

Some very big swings in the glide path, on average, over either one quarter or over the course of a year.

Cameron Passmore: How do you measure the intended glide path of a fund family?

David C. Brown: That's what's really hard to understand. What is the strategic glide path versus the tactical glide path? The strategic asset allocation versus tactical asset allocation.

Strategic generally is thought of as these long-term shifts of, okay, we've done a bunch of research and we've decided that we do want to increase the overall equity exposure. This happened with Vanguard. I think it was back in 2016, but they made a big strategic shift and all of their glide paths shifted up, essentially, versus tactical changes are, ooh, our capital market assumptions have changed for this year.

We really think US equity is going to outperform international equity, and so we're going to switch and up US by 5% and decrease international by 5%. That'd be more of a tactical change. The problem is as researchers, we can't get in the TDF manager's heads and they don't put out press releases that say exactly what they're thinking when they make these changes.

I think it's really important to note that we are not capturing the intent really at all. It's just when they made changes, did those changes end up to be good moves or not? That's the analysis that we can do.

Ben Felix: You're estimating what their intended glide path was, but you don't actually know what it was.

David C. Brown: Exactly.

Ben Felix: And then you're measuring whether they deviated from what you're estimating their strategic allocation to be.

David C. Brown: It's a couple layers here. The basic idea is that we know the glide path is downward sloping. We can see how it changes from 2025 to 2030.

As we go from 2025 to 2026, we can expect a little bit of that drift to be incorporated into their asset allocation over time. We expect equity to go down a bit, almost zero if it's a long out retirement vintage like 2060s. If it's 2025, we expect a more significant decrease in equity.

Then we can say, okay, we expected equity to go from 50% to 49%. What actually happened? That's really where this next level of research goes is to say, how much was that change?

What direction was it? Did it actually lead to better returns or not?

Cameron Passmore: What effect are increasingly active tactical glide path changes having on the target date fund returns?

David C. Brown: On average, not a good effect. These are not huge effects. In the last paper, we were talking about 1% per year. We find about a 10 basis point effect here.

On average, because they're changing their glide path, it's hurting returns by about 10 basis points. Not huge, but when you think about Vanguard, 10 basis points is about what their fee is. If all of a sudden you're layering an extra cost on top of investors by essentially being active when you didn't have to be, these managers could have essentially said, hey, here's our glide path.

We're going to stick to it and they would have done better. That's the overall industry picture. That's not true for every manager at every point in time, but that's what we've seen on average over the last 20 years or so.

Ben Felix: The managers, they're not saying that they're doing this, if I understand correctly, because you're estimating what the intended glide path was and then measuring deviations from that. Fidelity is not coming out and saying we're overweight, whatever, in our asset allocation this year.

David C. Brown: Certainly not with the target date funds. I think, again, you get some of this discussion when they talk about their capital market assumptions, and that's more fund families overall putting these assumptions out there, but you don't see it in a narrative from the target date fund managers. It is a question of, I still wonder exactly why they're doing this.

Some of the managers, you get a chance to talk to them and they have convictions around those capital market assumptions. They really believe that they know what they're doing and that this is going to better position their investors. I've never gotten a sense that anybody is trying to do this against their investors.

Everybody's trying to help the investors and get them better returns and get them successfully to retirement. All the good intentions in the world are there. On average, the industry just doesn't seem to be delivering where they think they can.

Ben Felix: Man, so why are they still doing it if it's leading to underperformance?

David C. Brown: I think this comes back a little bit to your talking about behavioral things earlier. We are people. One of the biggest things we see is that the underperformance from being active tends to concentrate when people chase returns.

I see that equity has overperformed in the last quarter, and rather than rebalancing back towards my intended or my previous glide path, at least, instead I end up chasing that and saying, okay, just again, as an example, to make things concrete, you're 50-50 to start the quarter and equity outperforms bonds. Maybe you end up just because of returns at 52-48. The rebalancing would have you go back to 50-50 and maybe actually decrease equity slightly to follow that glide path.

Instead, a lot of these fund companies are actually chasing and saying, well, let's go 54% equity next quarter. To an extent, there is a momentum effect. They might be trying to pick that up, but they don't seem to be doing it successfully over time.

Ben Felix: I don't think people using targeted funds realize this is happening.

David C. Brown: No, not at all. Whenever I present this paper, people are generally shocked that there's that much change in the glide path because glide paths are thought of as very stable. We're just basically giving you this asset allocation and making small tweaks per quarter.

When you actually go to implement these things, there are all sorts of money flowing in, there's all sorts of money flowing out depending on which vintage you're in. As a result, there's a lot of management that has to happen to keep that glide path where you want it to be. Returns are going to be different across asset classes.

You do have to think, how are we going to rebalance? That's a very active choice in managing the fund. With all that, it introduces scope to make these other changes as well.

Cameron Passmore: It's really hard to keep the human bias out of this systematic platform.

David C. Brown: Especially when you're getting paid to manage the fund and the pressure to come up with your best ideas and put them into the fund, even though those best ideas might be really hard. Predicting macroeconomic trends is not easy. Active managers picking stocks is hard.

I think it's generally accepted. It's even harder to pick macro moves.

Cameron Passmore: So, how do you know you're not just observing incomplete rebalancing at your sampling intervals?

David C. Brown: Again, we only observe quarterly, so we can't fully rule out rebalancing. This is the academic in me. However, what we can show is, look at people making that move from 50% to 52% because of returns.

We can ask, what percentage of the time do they actually continue on and chase the return versus rebalance it? 38% of the time, people are actually going to chase that return. About 24% of the time, they're in the middle.

The rest, they're actually rebalancing the other direction. Essentially, we can show how often people are chasing returns. We're pretty confident that most of it is not driven by a lack of full rebalancing.

You can actually see big patterns across different fund companies. Vanguard, they almost entirely rebalance every quarter. American Funds is another that rebalances most of the time, whereas JP Morgan or Fidelity, they tend to be much more active and more likely to be in that return chasing category.

Ben Felix: It's really interesting that it like that. What's your big picture main conclusion on how these tactical glide path changes are affecting target date fund performance?

David C. Brown: For right now, it's not good. It's that when fund managers are active, they are doing so to the detriment of investors. It would be better if the whole industry decided to just set the glide path and implement it rather than making these tweaks.

Does that mean they shouldn't have researchers working on this and trying to figure out better glide paths? No, but I think there should be some tempering of how aggressive they are in making these changes. Another stat that I find crazy is that in any given quarter, 40% of TDFs either add or delete a fund holding.

So, they're taking a fund out and replacing it with something. Maybe it's a large cap for another large cap, or it could be that large caps switching out for a bond fund. But the fact that they're switching out that frequently tells me maybe we should all just say, "hey, it's okay to not do too much."

"Maybe that should just be a mantra in the industry for a little while." "And hopefully investors will do a little bit better because of a lack of activity."

Cameron Passmore: Okay, our final few questions for you. So, based on all your research, what are your views on the state of target date funds?

David C. Brown: I want to start out by saying I am a big proponent of target date funds. When they became a QDIA in 2006, what they replaced were basically money market funds. So, 20 years ago, investors, if they didn't pick any other asset allocation, would just have their money in cash.

They would earn very little, no stock market exposure, not going to set you up for a very good retirement. So, shifting to TDFs has been a massive positive improvement for investors. There are huge trends in the industry that are decreasing the costs, and there are more and more really great products out there for people to use.

That all said, there's this huge dispersion. So, there's still a lot we can do to make TDFs better. And that's what I view as my role as an is to help people understand, one, there is this dispersion, but two, there are ways to find out whether your fund is performing well or poorly.

And then you can make a change based on that. So, my co-author and I want to get our data out there. That way, people can make better, more informed decisions.

You guys mentioned that these are less of an issue in Canada, and I think similarly in Europe. But I talked to a provider earlier this week, that's actually launching indexes in Europe for TDFs. So, these are products that are coming out soon.

I think TDFs are going to start bleeding into other spaces as well, making them even more important for us to understand well, and hopefully to make people understand and see exactly what's going on in them.

Ben Felix: I want to come back to something we talked about earlier, just about the differences in glide paths. So, if someone goes to the website that you've created and finds a fund that's underperforming its asset allocation matched benchmark, if they go and ditch that fund for one that has performed better, but they end up with a conservative overall portfolio, is that good or bad?

David C. Brown: Good question. I'm not going to say it's necessarily good or bad. It depends on what market returns are over the next however many years.

I'd expect them to generally be positive. Markets go up over time for the most part. But my big question would be, are they going to know which one's going to be riskier or not?

And this is a weakness in the data that we have out there so far. Right now, we are benchmarking to that replicating fund without considering the total risk level. This is something we've realized.

And so we're working on developing some new tools. They're really aimed more at plan sponsors and consultants in the industry or people that are trying to provide advice on TDFs to really give you a deep understanding of the asset allocation behind each TDF, how that's evolved, and essentially do risk adjusted benchmarks in addition to the benchmarking that we've done and talked about today. That's where we're going with the website.

We're not there yet. But I think that would be my big thing is say, hey, if you can isolate on risk level, so if you have the risk level you like, now pick the thing that's performing best within that risk level. And so I think that's a really good question from your perspective to say, let's think about risk level first before we necessarily hone in on how operationally effective you are.

Ben Felix: That would be super valuable if you could hold the risk level constant, then you could find the most efficient fund at that asset allocation. Safe to say though, you still think targeted funds are definitely a net benefit to investors because it's much better than sitting in cash, but some work to be done potentially, including work to be done on the ability to analyze and compare funds even beyond what you've done so far.

David C. Brown: Exactly. Because you do want to do that risk-based adjustment. And then you can start putting yourself into the right category.

I mean, there's a whole other question of do you know how to put yourself into the right risk category of a TDF? That's a big struggle with the industry. At the end of the day, that comes down to better education, which lots of people are pushing for in this space.

Hopefully, this can become part of that education as well.

Ben Felix: I've got to ask since you brought it up earlier, what are your views? You've done all this work on target date funds. You've been talking to plan sponsors.

What are your views on the Scott Cederburg 100% equity lifecycle portfolio research?

David C. Brown: I think it's phenomenal research that Scott's done, Scott and Michael and Aizhan all together. Personally, I have moved more of my portfolio that direction. In full disclosure, I am much more into the basically half and half international equity now.

I used to have a bigger bond position. I've followed their advice. Part of the reason I've done that is I think I have the stomach to handle downturns.

The biggest problem is the behavioral side. If you're going to be all equity invested, and we have some big global event like the global financial crisis happen again, it's going to be okay if you can withstand it and you're not going to sell at the bottom. But time after time, studies have shown that people do.

I'm in a very fortunate position. I'm tenured here at the University of Arizona. My income stream is pretty comfortable.

I've amassed a decent amount of savings to where if it got cut in half, I'm not going to freak out. Maybe I would, and maybe I'd regret everything I'm saying. But because of that, I think you can invest more aggressively.

Is that better for everybody? I'm less convinced. Especially when people can pull the trigger themselves to take money out.

Studies have shown that investors are less likely to take money out of a TDF to sell it and move to something else because they're in a TDF versus other assets. So, that's good. People are doing this less.

But would that effect go away if we went to these all equity portfolios? Especially if there's a bunch of people that are having not the all equity portfolios. Because if you see my buddy down the hall, his fund only went down 20% and mine went down 40%.

Now you're going to have even more bad feelings around it. Dealing with these behavioral concerns are paramount to figuring out how to get people better portfolios for the long run. Because I do believe if you can maintain it, the data shows over a huge sample of places in time that that works.

Now holding the portfolio is a whole other thing though.

Ben Felix: Yeah. I think the behavioral thing is a big piece of that for sure. You mentioned it, but I've seen literature from a couple of different record keepers from Fidelity and I think...

T. Rowe Price showing the data that you mentioned where they have plan participants changing their asset allocations. The incidence of that happening is much higher for people who don't have 100% of their portfolio in a target date fund. It's minimal, like almost zero.

We can put one of these charts in the video for people who are at 100% of their savings in target date funds. It is pretty interesting to see that. I think it's a really interesting question to think about would that change if the target date funds were 100% equity portfolios instead of whatever their current allocation is.

David C. Brown: My gut would say no, because most people aren't thinking about this decision. They're getting into the default and they're sticking with it. They're not going to really question it.

It's the people that are paying attention that then log in and see how they've done poorly and then decide to make a change. It's one of those, if you could just commit to not looking at your account for a decade, you would probably be better off. I think there actually might be scope for that in the future of providers creating products that people just can't touch.

Ben Felix: Like a lockbox.

David C. Brown: Exactly. These happen in private equity and we're talking all about making private equity public now. Maybe we should be thinking about the features of private equity that we can just put on public equity to make it work better for the investors and prevent these behavioral mistakes that happen time after time after time and are probably going to keep happening.

Ben Felix: Maybe that would break the expected returns though. One of the early criticisms of Scott's paper, they took it out of the paper entirely, I think was the equilibrium effects of if everybody did this, then the result would not hold. I think for the behavioral reasons that you've outlined that that's probably not a risk, but if we created private equity like lockboxes where people could take public equity risk without feeling like they're actually taking it, that might have more significant equilibrium consequences.

David C. Brown: Well, it might get to the money doctors in a sense that people can feel like they can take more risk if they know they're not going to hurt themselves on the back end.

Cameron Passmore: Isn't that interesting?

David C. Brown: I think to your point, the equilibrium consequences, Scott's paper essentially goes to would there be a bond market? Right now, there's a huge bond market. I don't think it's going away tomorrow.

Ben Felix: For the behavioral reasons, I don't think it's going away. I've asked a bunch of our portfolio managers at PWL. They're familiar with Scott's research.

They've listened to him on our podcast. They've heard me talk about his paper. I asked them recently, all of them, why are your clients not in 100% equity portfolios?

You know what that research says. I got a bunch of really interesting answers, but a lot of them were focused on that behavioral component. Yeah, we know what the research says.

The client knows what it says, but they still don't want to be in a really volatile portfolio. Even if they understand that in the long run, bonds might have their own unique risks and maybe even be a little bit riskier. They still don't want to see that volatility in their account.

It helps them sleep at night. It's hard to make that go away.

David C. Brown: Unless we don't look at it.

Ben Felix: Yeah, that's true.

Cameron Passmore: After all is said and done, what do you hope that individuals and plan sponsors will do with the great research you've done?

David C. Brown: Use it to make better decisions. Our whole goal is to make the industry more transparent. If we can give people the tools to make better decisions through both understand the operational efficiency of TDFs, understanding where they're taking the risk and how that compares to other TDFs that are out there, and then ultimately get into better products. Because we do see such dispersion.

I mean, there are still S&P 500 index funds out there that are charging more than a percent per year that still have assets under management. It's all about education and transparency to get people away from these funds that are just too expensive. We hope that our research are going to drive people towards that and ultimately make the whole TDF industry better.

Hopefully retirement investors are better off in 30 years, thanks to the research we've done.

Ben Felix: Yeah, that's a good answer. On the not looking at a thing, we had a past guest. I can't remember who it was.

I want to say it was Robert Merton, who talked about focusing on payoffs. Instead of focusing on what is the present value, what is the mark to market value of the asset, you can focus on what is the expected future payoff. I think John Cochran talks about that in his paper on portfolios for long-term investors too, where he talks about the inflation index perpetuity is risk-free for the investor, but it's going to be super volatile.

But if you focus on the payoff, you focus on the whatever the annuity payment is going to give you, it feels risk-free. Making public equities illiquid or locking them up or whatever, I don't think people would do that. I think it would end up being like annuities where nobody wants to buy them because you're giving up control or whatever.

I wonder if there's an opportunity for providers or even wealth management firms like PWL to show the expected retirement cashflow stream and how that changes over time instead of showing the mark to market value of the asset. Maybe that helps people stay invested.

David C. Brown: I think that's a great idea. More behavioral research needs to be done and also think about the policy implications and whether you can get people to go this direction. Ultimately, we got to get people to do it and whether that's through regulatory channels or actually just seeing that the market shows that people want these products better and they want this view better.

We've gone to a world where people are looking at their accounts through Robinhood and day trading, single day options and this kind of thing. We've gone the other direction. Maybe we can start working our way back.

It's a tough thing to do in an era where investing is basically being gamified for better or for worse.

Ben Felix: Yeah, you're right. Things are going in the wrong direction and technology is pushing things in the wrong direction. That's a tough one to reverse, I think.

It's interesting to think about. We do tell our clients what their expected retirement income is and how that might change if the market goes up or down or bond values go up or down or whatever. We update our expected returns semi-annually.

We have pretty good information to our clients about this is how much you can spend in retirement, which is really what people care about. But they still want to know what the mark to market value of their assets are. I just don't know if you can make that piece go away.

David C. Brown: It's a fair point. People want to know what they're worth right now. The more you're thinking about it and planning for it, the more you start paying attention to it, especially as you get older and you get to those periods where you really don't want to sell right before you hit retirement when you get a big downturn.

It's a hard problem to solve and I think that's why we don't have a solution for it yet.

Ben Felix: Yeah, super hard. You can't go to a client and say, "no, no, everything's fine." "The expected returns went up." They don't hear that.

David C. Brown: Double down. Let's mortgage your house again.

Ben Felix: Second to last question here and a bit of a change of pace. What can you tell us about the Microsoft Excel Collegiate Challenge?

David C. Brown: Thanks for bringing it up, Ben. I just talked about gamifying investing. I don't love that.

What I do like is my other project I've been working on really for the last four years is gamifying Excel. Microsoft Excel. I don't know if you guys have seen Excel Esports.

Have you guys seen that on ESPN showing up occasionally?

Ben Felix: Oh, yeah.

David C. Brown: It's a new thing. Essentially, I am the founder of the Microsoft Excel Collegiate Challenge. There's also a pro competition.

The program that I founded is really all about providing education for students to get them ready for their careers. I teach financial modeling here at the University of Arizona. So, it's naturally a finance plus Excel class.

But in so many other classes, even across the finance department, it's hard to get real world skills that these students need when they graduate into the classroom. I need to cover Black-Scholes in the options class. I don't have time to show them how to build a binomial tree efficiently in Excel.

Anybody can do it cell by cell, but can you do it in a very efficient way that saves you time and lets you focus more on the analysis and the thinking part? That's what the Microsoft Excel Collegiate Challenge is all about, is gamifying Excel, giving students a way to engage with really just fun, creative, problem-solving challenges. That way, they're building up their resumes at the same time as having fun.

We currently have over 12,000 participants around the world. We have big finals event in Las Vegas. It'll be on ESPN this year.

So, we're really excited to see lots of teams there. We have a couple of Canadian teams. I don't know if anybody's planning to make the trip down to Vegas yet, but anybody that's out there that is out of school, wants to have a team come, please reach out.

We'll get you guys involved.

Ben Felix: That is the nerdiest thing ever, and I absolutely love it.

David C. Brown: And you're here for it.

Cameron Passmore: Yeah, it's very cool.

David C. Brown: It's even nerdier when you put the jersey on. Send me your sizes and we can get you guys some jerseys.

Cameron Passmore: That's so funny. Oh, man. Last question, David, how do you define success in your life?

David C. Brown: I thought a lot about this one because you guys always ask the question. And I feel very, very fortunate to be where I'm at. In a sense, I feel like I have the greatest job in the world for me.

I get to work on what I want to work on, when I want to work on it. I was fortunate enough to have gotten tenure a few years ago. That's when I started the Microsoft Excel Collegiate Challenge.

I feel like I've achieved success. But going forward, it's all about balance at the end of the day. I've got a lot of different opportunities, things to work on.

I want to make TDF investors better off. I want to do more research just to understand it. I want to make students better off.

And so as long as I'm balancing how I'm adding value to the world, then I think I'm succeeding. And the part that I'm really working on more is balancing my own personal interests outside of work, so to speak. I've actually been able to play more tennis and more rock climbing over the last year because I'm a little bit more focused on balance than I have been in the past.

If you ask me in a year or two, if I've done a good job of balancing all my interests, that'll be my measure of success going forward.

Ben Felix: Great answer. David, it's been a great conversation. We really appreciate you coming on the podcast.

David C. Brown: Thank you guys very much. Really appreciate it. And check out our website so you know whether your TDF is doing well.

Ben Felix: Yes, we will link that in the episode description so people can check it out. I have used it. It's a really interesting site to explore.

Cameron Passmore: Awesome, David. Great to meet you. Thanks for coming.

David C. Brown: Thank you guys very much.

Disclosure:

Portfolio management and brokerage services in Canada are offered exclusively by PWL Capital, Inc. (“PWL Capital”) which is regulated by the Canadian Investment Regulatory Organization (CIRO) and is a member of the Canadian Investor Protection Fund (CIPF). Investment advisory services in the United States of America are offered exclusively by OneDigital Investment Advisors LLC (“OneDigital”). OneDigital and PWL Capital are affiliated entities, however, each company has financial responsibility for only its own products and services.

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