Target-date funds (TDFs) are not as dynamically managed as they could be, according to a new report from AllianceBernstein titled “Designing the Future of Target-Date Funds.” Specifically, they need to invest in a broader set of asset classes, beyond traditional stocks and bonds, moving into commodities, real estate and other liquid and illiquid alternatives, for example. AllianceBernstein also charges the funds to adopt an open architecture approach, whereby they invest in multiple rather than single asset managers, and to respond more dynamically to market volatility.

”While target-date fund assets have grown rapidly, innovations in these funds’ investment designs have occurred at a shockingly slow pace,” says Dan Loewy, chief investment officer (CIO) and co-head of multi asset solutions at the institution. “Our latest research creates a blueprint for target-date design that provides plan sponsors with a clear roadmap for building retirement income for the future. We’re looking to provide a target-date design of tomorrow that utilizes a multi-manager open-architecture structure, incorporates a broader collection of diversifying assets and that can dynamically adjust the glide path according to market conditions—tapping the best of active and passive investment approaches to create better solutions for participants’ distribution phase.”

The report says that a broader range of investment strategies is now available to asset managers. “These strategies can help reduce sensitivity to market, interest-rate and inflation risks at different points in the glide path,” the report says. This is critical, as 72% of retirement plans use TDFs as the qualified default investment alternative (QDIA), according to AllianceBernstein. “We feel it’s time to revisit target-date funds and assess what we can do to make their glide paths and overall design work more effectively for the long-term retirement needs of workers,” the firm says. “If the target-date fund isn’t enhanced over time, it can’t be positioned to meet the needs of a growing number of participants who rely on it for their retirement confidence.”

Large defined contribution (DC) plans are leading the way in TDF best practices, according to the report, with many using customized TDFs in order to gain control over the managers (cited by 34% of large plan users) and to obtain a more diverse asset allocation (cited by 31%). “The largest DC plans have taken note of institutional best practices and gravitated toward customizing their target-date funds, tailoring the asset allocation to participant demographics,” the report claims. “That diverse mix often incorporates a range of alternatives and nontraditional investments to further diversify traditional stock/bond allocations.”

In addition, advisers and sponsors need to be attuned to the expanding “menu of risk-management tools,” such as long-short equities and credit and unconstrained bonds, the firm attests. Later in the glide path, investors need protection from inflation and market risk, the report argues. Real estate, commodities, inflation-protected bonds and Treasury inflation-protected securities (TIPS) can help with inflation risk, while investing in lower-volatility defensive equities and companies with higher quality cash flows and dividends can help mitigate market risk, according to the company.

As for interest-rate risk, AllianceBernstein recommends high-income strategies like high-yield and emerging-market bonds, global bond strategies hedged to the U.S. dollar, low-duration strategies and nontraditional fixed income focused on absolute returns, such as high-yield bonds, securitized loans, foreign sovereign bonds and corporate debt.

Alliance Bernstein’s full report can be viewed here.