State of the Industry
A preponderance of target-date fund strategies emphasized the need for an evaluation process
Nearly three out of four (73.3%) plan sponsors use a target-date fund (TDF) as their default investment, according to the 2018 PLANSPONSOR Defined Contribution (DC) Survey. The percentage was almost 13% less—60.6%—in 2014. It is easy to understand the appeal of these funds: a single investment solution that offers a diversified, self-adjusting asset allocation, which has the ability to keep participants onboard for the long term—sometimes referred to as “set it and forget it.” The general premise of a target-date fund is that the asset allocation becomes more conservative as it gets closer to its target date, though how—and when—varies from manager to manager.
However, according to a recent survey from J.P. Morgan Asset Management, while 75% of sponsors are highly confident in their selection and monitoring of TDFs, 30% said they lacked a solid understanding of how their TDFs work. As more and more funds appear in the marketplace, it is increasingly important to be well-informed so you can choose the right one for your plan.
As established as target-date funds have become, managers continue to develop their thinking and underlying allocations—and there is still room for new entrants. This evolution in TDFs may include changes in allocation targets or underlying funds. For example, new to the survey this year are Total Advantage Funds from Legg Mason. That company saw an opportunity to introduce what it describes as “a unique combination of proprietary features [that] works to elevate the certainty of outcomes through next-generation diversification and a process of adaptive allocation in a CIT [collective investment trust] structure.”
While the survey is not inclusive of every product in the TDF universe, our participation rate of 70 TDF products encompasses $1.8 trillion, as of June 30. Of the target-date fund market reported, 38 are in mutual funds, 24 in CITs and eight in variable portfolios.
The following analysis is based on the 70 off-the-shelf, or prepackaged, products in our listings (custom solutions are excluded).
Key to any plan sponsor due diligence process that involves fund differentiation is to examine the asset manager’s philosophy and methodologies such as how he may use passive management or unaffiliated investment managers.
There is a range of reasons for plan sponsors—whether they are seeking active, passive or some sort of hybrid/blend option—to scrutinize funds’ management style.
This year, 21 out of 70 funds use a hybrid or active/passive approach; 24 use an active approach; 19 use an index or passive approach; five identify themselves as “blends,” and one is factor-based. Passive exposures help keep participant expenses low, while active exposures provide participants the potential for added incremental returns and the mitigation of key investment risks, according to a recent PGIM Investments report.
One reason PGIM suggests that hybrid approaches may be on the rise now is that active exposures can help mitigate market declines and interest rate volatility.
This year’s survey shows an increase in the number of TDF products that allow the investment manager some tactical deviation from the glide path—to 42, up from 36, when we last ran our TDF Survey, in 2017. Is this an indication that managers are preparing for increased market volatility and want to have flexibility to respond?
Another area that has evolved over multiple TDF surveys is the number of funds that include nonproprietary funds within the investment. This presence of an unaffiliated manager overseeing at least one part of the portfolio is referred to as open architecture—it can help firms avoid a conflict of interest if they offer nonproprietary products in their TDFs. Thirty-two of the funds we list provide this feature; however, the managers of the largest TDFs—Vanguard, Fidelity, T. Rowe Price and American Funds—do not.
Of course, there are also options beyond off-the-shelf funds. Sponsors unable to find an appropriate prepackaged TDF solution might consider a custom fund. Thereby, the sponsor can work with an asset manager to specify glide path construction, underlying asset allocation and ongoing advisement. Eight asset managers provided details about that option.
—Judy Faust Hartnett