Academics Say TDF Managers Take Advantage of Low-Attention Investors

The three professors say their research shows the importance of transparency.

In a research paper, “The Unintended Consequences of Investing for the Long Run: Evidence from Target-Date Funds,” academics say managers of target-date funds (TDFs) take advantage of investors’ set-it-and-forget-it mentality.

The paper says managers do this by delivering lower performance of 2.9 basis points (bps) for each year from the vintage year. For an investor holding the fund for 50 years, that would mean a 21% reduction in performance.

The researchers—Massimo Massa, a professor of banking and finance at nonprofit university INSEAD; Rabih Moussawi, an associate professor of finance at Villanova University; and Andrei Simonov, a professor of finance at Michigan State University—also say that TDFs invest in more expensive share classes of underlying funds because TDFs often invest in funds in their own fund family.

“Indeed,” they write, “a longer investment horizon will potentially increase the agency problems, providing the manager with more opportunities to favor his family’s funds at the expense of his own performance.” 

The number of TDFs grew from just 63 in 2000 to 2,778 in 2019, with total market capitalization surpassing $1.4 trillion. In 2019, the academics say, 58% of TDFs invested only in funds of their own company, and another 20% invested between 50% and 99% in the same families’ funds.

Perhaps more significantly, the professors say, “as the funds are very far away from maturity, new flows are way less sensitive to performance.” The Pension Protection Act (PPA) that permitted plan sponsors to use TDFs as the qualified default investment alternative (QDIA) has “created a pool of ‘captive’ and low-attention investors in TDFs,” they say. “Fund underperformance is more pronounced and significant, statistically and economically, for funds with longer horizons.”

Furthermore, they continue, “given that 74% of TDFs’ assets under management (AUM) are invested in the family funds, families may lure in investors with low fees on the TDFs—the ones directly observable—and charge higher fees on the underlying funds, the ones less observable.”

In conclusion, the researchers say, “Our results underline the importance of an open-architecture structure at the fund level. … Another takeaway is the importance of transparency in the risk level that TDFs are taking, both for short and long horizons.”