New iShares Target-Date ETFs Try A Different Approach

iShares has just issued a dozen new unique ETFs that track the S&P Target Date Index Series and the Target Risk Index Series.

The S&P Target Date Index Series and Target Risk Index Series are composed entirely of iShares ETFs, similar to a fund of funds. Each underlying ETF is chosen as a broad representation of an asset class. According to Standard and Poor's Target Date Index Series methodology guide:

"The index series reflects the market consensus for asset allocations for different target date horizons. In particular, each index is representative of the investment opportunity available to investors for the corresponding target date horizon, with asset class exposure driven by a survey of available target date funds for that horizon."

This means that it is the two index series' intention to provide a benchmark based on asset allocation opportunities available in the marketplace.

This is different from most indexes that systematically hold the entirety of or a representation of an investable universe, defined by an asset class, style, sector, industry, etc. These indexes instead represent aggregate asset allocations by each index's mutual fund peer group.

To determine the asset-class weights for each target date and target risk index, S&P surveys mutual funds categorized as Target Date funds or Target Risk funds by the Lipper and Morningstar databases. After surveying a category peer group, a trend line is fitted to the data points, only utilizing asset classes with more than 1%. Measures are taken to solve an outlier effect without removing the number of funds used in the survey. The indexes are rebalanced annually using the same surveying method.

The goal of these indexes is to represent allocation decisions among asset classes; not sector, style or individual security selections. To represent an asset-class allocation, iShares ETFs are used. It is very clear that S&P intended and designed the indexes to become ETFs.

It is interesting that S&P chose ETFs as the underlying assets instead of the indexes that those ETFs track. This makes the creation and redemption of the ETFs simpler since hundreds of individual securities are represented by the underlying ETFs.

The expense ratios of the target date and target risk index funds listed above include the expense ratios charged by the underlying ETFs of each fund. The expense ratio fees of the underlying ETFs, which are all iShares products, are discounted when held by the fund.

Listed below are the ETFs S&P can employ for asset allocations that are determined for their Target Date Index and Target Risk Index Series. Each index may or may not contain all these funds depending on their asset class inclusion in each index.

Unlike other ETFs, target-date ETFs have an ending signified by their given target date. The S&P Target Date Retirement Income Index Fund (TGR) is designed to be the end point for all target date funds. According to S&P, three years after an index's target date, the target date index will then match the Retirement Income Index. Once an ETF reaches its designated target date, it will be rolled into the S&P Target Date Retirement Income Fund. The ETFs tracking the indexes should follow this same method.

By creating ETFs made entirely of ETFs, highly diversified global portfolios diversified among asset classes and all sectors, give investors a one-stop shop for risk-managed portfolios or risk-appropriate portfolios.

For individual investors, the trading cost of trading several ETFs can be eliminated to one ETF, since the ETF is a representation of nine other highly diversified funds. Also, these funds can act as an investable benchmark against their advisor's performance or be used by individual investors who want exposure to asset classes like emerging markets and international, but are not sure what their exposure should be given their risk tolerance.

These ETFs are designed by sponging off of mutual funds the aggregate of their asset allocation decisions while removing their market-timing and stock-picking decisions. Interestingly, these ETFs depend on mutual funds for their allocation results and therefore are perfect substitutes, suited to outperform the average comparable mutual fund taking into account fees and expenses.

The question is not whether these ETFs will compete with mutual funds and advisors but where they will compete.

Target funds are very popular in retirement 401(k) plans, thought of as an autopilot approach. With software being developed to trade ETFs on an omnibus trading platform, ETFs can now be offered in a complete way to plan participates.

The need for this kind of ETF has been clear and many companies and advisors have been offering target-date and risk-profiled model portfolios made from ETFs.

WisdomTree, a major frontrunner in offering ETFs in 401(k) plans with an omnibus trading platform, has been providing model portfolios for 401(k) plans constructed entirely of ETFs.

The similar iShares ETF products bring more transparency by providing a direct way to invest in the model. The drawback to the ETF structure relative to an advisor's model portfolio is that the iShares ETFs will change weightings as market prices change, and weightings can be shifted away from the original allocation when you invest since the fund is rebalanced annually.

With WisdomTree's models, one can invest in the model allocations when they decide to invest, siince the investor's problem will be solved once the fund is rebalanced annually.

Without a doubt, these 12 funds open doors to new ETF investors, provide direct competition to mutual fund assets in 401(k) plans and prove that having an all-ETF portfolio is accessible, cheap and potentially optimal. I am happy to say that these new advances in ETFs fit with traditional indexing strategies, providing a framework for indexing to work with all platforms, for all investors and at very cost-effective prices.

iShares is actually not the first to have target-date funds, TDX Independence was. Last year, TDX Independence issued four target-date funds and one retirement fund, the TDX Independence In-Target ETF (TDX).

On average, the TDX Independence funds are twice the price of the similar iShares products and are based on the Zacks Investment Research Lifecycle Index series. The index structure tries to select equity and fixed-income securities that they believe will outperform the benchmarks.

This is very different from the S&P series, which is more systematic and utilizes indexing principles.

Kyle Waller is a research analyst at Wiser Wealth Management in Marietta, Ga. He invites comments and suggestions for future columns at: This e-mail address is being protected from spambots. You need JavaScript enabled to view it .