TDF Analysis | Published in November 2016

ETF Inclusion in TDFs

Spotlighting industry data from PLANSPONSOR’s proprietary research

By Matt Cirillo | November 2016
Exchange-traded funds (ETFs) may have finally found their point of entry into the defined contribution (DC) market, having faced barriers to acceptance as a standalone investment option. They have begun to gain traction as underlying investments within other vehicles, such as target-date mutual funds (TDFs). The emergence of ETFs in TDFs is linked to the latter strategy’s favored status as a qualified default investment alternative (QDIA). Still nascent, ETFs account for approximately 2% of the $861 billion TDF market. While J.P. Morgan and Wells Fargo have incorporated ETFs within smaller, more recently launched supplementary series, John Hancock is the only manager in the top 10 by TDF assets that uses ETFs in an established series with meaningful assets.

The utilization of ETFs as a component of TDF construction aligns with a broader trend toward the use of index funds in TDF products. Facing considerable pressure to both contain costs and manage capacity, many managers have incorporated index funds as a means to achieve those objectives. Each of the top three TDF managers—Vanguard, Fidelity and T. Rowe Price, which collectively account for more than 70% of the market—utilize index funds in varying degrees, though none use ETFs to meet the above-stated needs.

To compete with the established hierarchy of TDF managers, newer entrants and smaller managers are significantly more likely to include ETFs in their TDFs in an effort to compete with the scale of larger managers. Consequently, ETFs are being used as core portfolio building-blocks, with 63% of ETF assets in TDFs distributed across three broad categories: intermediate-term bond, large blend and foreign large blend. Given the overall market forces weighing on all competitors in the target date market, the use of ETFs as a way to manage capacity and cost is a trend worthy of continued observation.

Manager Use of ETFs

ETFs in largest 10 holdings of top target date asset managers by size

Managers not including ETFsManagers including ETFs

ETF Asset Breakdown in TDFs