As part of the series of the „Finance Research Seminar“, VGSF welcomes Esther Eiling from University of Amsterdam to present her research paper.
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Paper
Target Date Funds and International Capital Flows
Target date funds (TDFs) are investment products designed based on the life-cycle theory to provide exposure to risky assets conditional on investors’ age. Even though life-cycle portfolio choice models do not distinguish between different subcategories of risky assets, we document that in practice, TDFs adopt and maintain rigid allocation weights to domestic and foreign equities. Our main finding is that TDFs implement contrarian rebalancing trades. These trades offset 53% of the mechanical allocation changes caused by realized differences in returns between domestic and foreign equities within the same quarter. TDFs are organized as funds-of-mutual-funds and their holdings account for 10% of the total assets managed by U.S. foreign equity mutual funds in 2022. We show that TDFs’ contrarian rebalancing trades have three implications for international capital markets. First, the growth of TDFs significantly changes the prevalent positive flow-performance sensitivity among mutual funds: foreign equity mutual funds with higher TDF ownership experience outflows when foreign equity outperforms domestic equity. Second, the returns on foreign stocks with higher TDF ownership co-move more with the U.S. equity market and less with the foreign equity market. Finally, at an aggregate level, currencies affected more by TDF rebalancing flows appreciate more when the U.S. stock market delivers higher returns.
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