Target Date Funds (TDFs) are becoming more widespread in Latin America, with pension reforms introducing or allowing them in countries such as Mexico, Costa Rica, Chile, Colombia, and Peru. These funds automatically adjust investment risk based on the member’s age, progressively reducing it as retirement approaches. The other approach used in the region is the multifund system, which aims to maximize returns by allowing members to choose their preferred level of risk among different investment options.

Multifunds offer advantages such as the ability to compare different investment alternatives, extensive international experience in their implementation, and relatively simpler operational deployment, although strategy shifts can be abrupt. On the other hand, the advantages of TDFs include international evidence supporting their effectiveness, the transfer of fund selection responsibility from the member to regulation (eliminating the need for financial literacy), and a management approach focused on long-term performance and strategic planning.

Mexico was the first country in the region to implement TDFs, increasing from 5 basic Siefores (multifunds) to 10 generational Siefores (TDFs). Preliminary evidence suggests positive results across several indicators:

1. Returns: Over the past five years, TDFs have delivered returns 214 basis points higher than those of multifunds. However, this difference cannot be attributed solely to the change in investment model, as returns depend on multiple factors.
2. Replacement rates: The Bank of Mexico estimated that the pension reform, along with the introduction of TDFs, would increase replacement rates across all income levels by improving savings accumulation and reducing costs.
3. Risk: A review of descriptive statistics on portfolio volatility shows a reduction in volatility following the transition to TDFs.
4. Weighted average maturity: After the implementation of TDFs, there has been an increase in the average duration of investment portfolios.
5. Portfolio diversification: Greater portfolio diversification has been achieved, reducing the concentration that basic Siefores had in debt instruments (especially government bonds).
6. Improvement in investment teams: AFORE investment teams have improved significantly, adopting long-term strategies, diversifying portfolios, reducing operational risks, and aligning investments with workers’ needs.

Pension Notes Nº 87