Target risk funds attempt to hold the level of risk, either on a relative or an absolute basis, constant over time. They are or have been offered by 50 mutual fund companies. Though sharing some similarities to target date funds, target risk funds have key differences. They are also not the most cost-effective investment option.

Target risk funds and target date funds are commonly funds of funds. They allocate their portfolios to funds managed by their fund family. Target risk funds can be categorized as being aggressive, moderate or conservative. Target date funds start as being aggressive and then reduce their allocations to risky assets as the stated target date approaches. In both instances, the funds achieve their allocation goals by altering the exposure to funds representing various asset classes.

Target risk funds may also invest in single-sector funds (about 30% do), tactical funds (25%) or single-country funds (7.5%). Such choices suggest the managers are more focused on beating a specific benchmark then reducing risk. On the other hand, a higher proportion of target date funds (40%) invest in commodities than target risk funds (27%).

The value target risk funds provide to investors is questionable. An analysis concluded that these funds do not provide added return relative to their risk profile; rather, they do the opposite.

Part of the reason is the drag on returns created by the fees. These funds initially reduce costs by investing in the low-cost shares of the funds held in their portfolio. The benefit of these lower costs is taken away by the additional fees added at the fund of funds level. In other words, shareholders of target risk funds do not reap the benefits of the lower-cost shares their funds hold.

Individual investors could do better by using exchange-traded funds (ETFs) to mimic target risk fund. Investors simply review the allocation of a target risk fund and buy a proportionate amount of ETFs for each asset class. The lower expense ratios of ETFs boost returns for the mimic portfolio relative to target risk funds, particularly for the aggressive and the moderate allocations.

Source: “Target Risk Funds,” Edwin Elton, Martin Gruber and Andre de Souza, SSRN,
December 16, 2014.