Dynamic Asset Allocation Study On Target Date Retirement Funds

In 1990s, the US market launched a new kind of mutual fund called target-date retirement fund (referred to as TDF), which decreased stock allocation as investors aging. Accompanied by the rapid development of US pension market, TDFs were quickly recognized and expanded, and became one of the most basic parts of the DC plans. In order to improve the popularity of DC plans, the US government issued Pension Protection Act of 2006, which allowed TDFs to become the " qualified default investment alternative" (referred to as QDIA). QDIA means if the employees don’t choose a specific investment target, the employer can invest pension fund into TDFs as default. The Act accelerated the development of TDFs, which doubled in asset from 2006 to the end of 2012. There are fewer pension plan mutual funds in China, nor does it formed the system of investment strategy and the theory of pension plan investment. There are only 3 TDFs in the Chinese market, which totaled a capital size of RMB7.778 billion as to the second quarter of 2013. The development of TDFs is worth expecting.This paper studies the dynamic asset allocation strategy used in TDFs investment, solves the optimal path of asset allocation, analyzes indicators under dynamic asset allocation strategy, such as AUM, retirement wealth ratio, cumulative distribution, shortage risk, excess earnings per downside risk, etc. The paper discusses in both theoretic and practical aspects how the dynamic asset allocation strategy can be effectively used in TDFs in Chinese market. The main contents of the paper are as follows: The second chapter introduces the theoretical basis of TDFs. One of the assumptions of life cycle investment model is Constant Relative Risk Aversion, which emphasizes that the tolerance of risk is constant as well as the ratio of risky asset during the decision making process. Then the multi-period investment model, i.e. life cycle investment model, was established on the basis of Markowitz mean-variance theory. With the addition of labor income, health risk, social welfare, and taxation, the life cycle investment model was becoming more and more efficient, and guided the investment of TDFs. However, the life cycle investment model didn’t take into consideration the inputs before retirement and the payments after retirement, which might deviate the theoretical profits from the reality. In regard of this issue, the asset allocation model brought liquidity and spread-period into operation, and formed dynamic asset allocation model, which laid a theoretical foundation for the target date retirement funds.The third chapter questions the traditional life cycle investment theory that it could result in shortage of retirement income. On this basis, the paper presents a dynamic asset allocation strategy, which adjusts asset ratio in line with the historical cumulative investment income. In the beginning, the investors put all or most of the money in the stock. Then on the evaluation day, the portfolio switches to low-risk asset category only when the historical cumulative investment yield exceeds the target yield. Hereafter, the actual yield is assessed on every evaluation day. The portfolio may switch back to risky asset when actual cumulative investment yield is below the target yield.In the fourth chapter, this paper tests and analyzes investment efficiency of TDFs under different strategies on the basis of the testing methods presented in the last chapter. The paper uses Excel and SAS software to retrospectively simulate the American capital market over the past 70 years, and evaluates the AUM, retirement wealth ratio, cumulative distribution, shortage risk, sensitivity of target yield on 8582 observations. Finally, the article reaches a conclusion that the dynamic asset allocation strategy outperforms traditional life cycle asset allocation strategy used in TDFs investment.In the fifth chapter, the article makes empirical study and analysis on the Chinese capital market in the reference with American experience. Similarly, the dynamic asset allocation strategy also exceeds traditional life cycle asset allocation strategy. This conclusion provides significant reference to the investment and asset allocation strategies of Chinese TDFs.Finally, the paper summarizes the empirical results in the last two chapters, points out the shortcomings of the study, and makes suggestions on the development and investment of Chinese TDFs.