Casey Quirk: New Battle Lines Forming in TDF Arena

November 2, 2009 ( - A new report predicts that rapid growth will restructure the asset allocation and packaging of target-date products, and that target-date and target-risk retirement vehicles will attract 80% of new and reallocated flows into defined contribution schemes for the next decade.

In fact, Casey Quirk & Associates predicts in a new research report titled “Target-Date Retirement Funds: the New Defined Contribution Battleground” that target-date funds alone will swell to $2.6 trillion of assets in 2018 (a point at which the report suggests the vehicles will represent nearly half the assets in defined contribution plans) from $311 billion in 2008 – an estimate that the paper describes as “conservative” in that they do not fully account for a number of additional catalysts, such as the introduction of automatic-enrollment IRAs and new regulations that could “further turbocharge target-date growth,” according to the report.  

While nearly 90% of the 400 plan sponsors surveyed as part of the study said they were satisfied with their target-date options, at least to some degree, nearly two-thirds said they would consider changes – a combination that the report’s authors say suggests that, while plan sponsors believe in the idea of target-date funds, they “now seek to improve its execution.”  

Principal Concerns

Three principal concerns are driving many plan sponsors to consider changes to their target-date arrays, according to the report:

  • cost containment,
  • liability protection and
  • desire for greater diversification among both asset classes and managers (among larger plans at least)

“Learning lessons from the financial crisis, many plan sponsors will seek cheaper or more innovative target-date options for their participants,” the research paper notes.   “That shift—and the unbundling it may unleash—will favor target-date vehicles that look notably different from the products available today.”

Different Directions?

The research paper notes that plans with between $250 million and $1 billion in assets want to build custom target-date vehicles, but still lack the size required to do so.   The report says that a large number of these plans will shift from their existing recordkeeper's actively managed product to passively managed third-party off-the-shelf target date funds. Plans with between $60 million and $250 million will shift from active to passive target-date plans as a more permanent solution, while plans with less than $60 million in assets cannot provide enough assets to attract any custom or third-party options, and few small plan sponsors have interest in exploring options beyond the recordkeeper's bundled products.

Additionally, the report says that more than 80% of off-the-shelf target-date products - those designed primarily as either mutual funds or collective investment trusts (CITs) - will be passively managed by 2018.

Asset Manager Impacts

For asset managers, Casey Quirk sees target-date funds becoming the primary source of investment only opportunities, swelling to more than half the investment-only marketplace by 2018, compared with slightly more than 10% today.   Along the way those opportunities might generate nearly $13 billion in annual revenues within a decade, more than six times the current amount.   Moreover, the consultant thinks that customized target-date options will balloon to nearly $1 trillion in 2018, from $53 billion today, led by larger programs, specifically those with more than $1 billion in assets.  

The report notes that recordkeeper-affiliated target-date fund managers "must act aggressively to maintain their economics, at least at the large end of the marketplace", going on to caution that, "if they fail to do so, bundled options will shrink to 25% from 44% of all target-date vehicles by 2018."   As for strategies for those recordkeepers to retain share, Casey Quirk suggests that they

  • Offer their own customized products
  • Create bundled decumulation strategies, and
  • Launching proprietary index funds.

According to the paper, most target-date funds do not address two key trends now reshaping decision-making processes, and therefore product demand, from defined contribution plan sponsors; rising investment sophistication on the part of plan sponsors who will be selecting the funds, and a rising focus on decumulation, as a growing number of plan sponsors had adopted that as an objective and "will therefore start to seek solutions that help them deal with this process," notes the researchers.

As target-date options grow, their use of techniques and structures common in the defined benefit

marketplace will re-arrange winners and losers in the target-date arena.   The report says that this evolution of target-date funds will create three distinct opportunities for asset managers:

  • Customized vehicles will represent as much as 38% of assets and 31% of potential annual target-date revenues by 2018. About $600 billion of such options will reside with active fund managers, many of which will be boutiques that offer non-correlated returns, real assets, alternative investments or market-neutral strategies designed to provide more cutting-edge investment results for plan sponsors.
  • Index vehicles will gather an estimated 30% of potential annual target-date revenues in   2018, with off-the-shelf vehicles accounting for nearly 90% of those fees (customized products will comprise the remainder). A proportion of assets currently managed in large-cap actively managed options with low tracking error will shift to cheaper, more defensible index options by 2018.
  • Actively managed off-the-shelf target-date products will find themselves confined to the remaining 42% of revenue, with much of this coming from bundled funds offered to the smaller end of the defined contribution marketplace. The market opportunity for third-party actively managed target-date mutual funds and collective investment trusts will shrink dramatically in relative terms, from 26% to 10% of defined contribution revenues.

Three Segments

The Casey Quirk report says that the growth of target-dates will split the marketplace of plan sponsors into three distinct segments.   The first, the largest plans who will work with an   "allocator", a consultant or investment outsourcing firm, marrying third-party asset managers to an open-architecture recordkeeping platform.   The second, the smallest plans, who lack the pricing power to attract the interest of target-date vendors beyond those already attached to their recordkeeping platform.  

That third group - and this is where Casey Quirk sees as the "true battleground" is one centered over off-the-shelf products, which it predicts by 2018 will account for more than 60% of target-date assets and nearly 70% of all target-date revenues. "Asset managers, particularly index firms, will pursue investment-only target-date business aggressively. Conversely, recordkeepers will seek to preserve and expand their bundled target-date business by changing their affiliated target-date options to meet client demands. For some, this will involve turning to subadvisors to handle some, if not all, of the asset management duties," say the report authors.

Still, the report notes that target-date funds have "time horizons measured in decades, and it remains uncertain exactly what combination of high returns and low volatility will win the race".   That said, the Casey Quirk report notes that "most" plan sponsors will select their off-the-shelf target date funds based on several factors:

  • whether assets are managed passively or not;
  • the institutional quality of the underlying fund managers;
  • the asset allocation method, particularly the diversity of underlying asset classes;
  • the rigor, particularly quantitative, in determining the glide path;
  • expectations set by the product, and whether they are met;

But most importantly, cost.