Schwab Makes the Case for Open-Architecture TDFs

April 16, 2014 ( – Charles Schwab Investment Management introduced a new unit class for its Schwab Managed Retirement Trust Funds (SMRT Funds) with a lower 35-basis-point operating expense ratio.

Jake Gilliam, managing director and senior portfolio manager at Charles Schwab Investment Management, tells PLANSPONSOR the SMRT Funds are collective investment trust (CIT) arrangements offered exclusively to qualified retirement plans. Beginning July 1, the new unit class will be available to retirement plans with $300 million or more in SMRT Fund assets.

Gilliam says Schwab uses the SMRT collective trust vehicles to deliver more customized and cost-effective target-date solutions to large retirement plans—especially those looking to break away from proprietary approaches to target-date investing. He explains target-date funds (TDFs) built through the SMRT Fund trusts feature an open-architecture approach and a wide array of choices in investment funds and strategies, all at a good value for participants.

“If you look at the average target-date product, it’s about 70 basis points to 90 basis points in expenses depending on the different class of fund you’re looking at and what the target date actually is,” Gilliam says. “So we feel the expense ratio of the SMRT Funds is obviously a strong differentiator.”

But it’s the open-architecture approach that really sets the SMRT Fund methodology apart, Gilliam says.

“We go out and hire best-in-class asset managers and pair them together to really build an institutional-type product that is looking across the whole investment universe to build a target-date portfolio,” he explains. “Like a DC consultant would construct a core menu working with a large plan, we do the same thing for our TDFs. It’s purely unbiased and constructed according to the best interest of the end investor.”

Gilliam contrasts the open-architecture approach with the “proprietary method,” through which investment shops build TDFs only using their own funds and managers. The open approach allows for freer choice for which particular funds will fulfill specific roles in the TDF—reducing the potential impact of commissions and other fees and ultimately driving down expense ratios compared with proprietary products, Gilliam says.

The open-architecture approach to TDF portfolio-building also helps prevent “groupthink,” Gilliam says.

“We’re looking to find best-in-class managers in each asset class, and then we pair them together in a way that diversifies the return stream and doesn’t overly rely on one shop or one method of thinking to run the TDF,” he explains. “So the appeal here is diversification not only of asset classes but also diversity of thought, which means better diversification in the holdings the end-participants will have. That should lead to a smoother ride and a better volatility pattern for the investor.”

Gilliam says the open-architecture approach also allows for more sophisticated glide paths. Asked whether the SMRT Fund trust TDFs should be thought of as an active or passive investment product, Gilliam says the answer is “none of the above.”

“They’re actually both active and passive,” he says. “We’ve learned that people view risks in TDFs according to a couple different common dimensions. They want to know if it’s active or passive, and they want to know about the glide path and the equity versus fixed-income exposures through time. But the real matter of analyzing a target-date fund’s investment philosophy is much more complex than those two factors.”

He says the SMRT Fund TDFs are tailored to not just change their equity and fixed-income exposures over time, but also to shift the levels of active management and passive indexing included in the portfolio depending on market considerations and evolving participant needs.

“To us, an 85-year-old investor who has long been in retirement should not have the same level of active management in the portfolio as a 25-year-old just starting out, so we build our funds to address that,” Gilliam explains. “It’s a more sophisticated way to approach risk than a lot of the off-the-shelf products that you see.”

When it comes to the other most common method of categorizing TDFs—“to-retirement” versus “through-retirement”—Gilliams says the SMRT Funds are probably best classified as “through-funds,” but he says the label is imperfect.

“To versus through is a really simple way to structure the argument, but it misses what a to-fund actually means in terms of volatility in the asset class exposure,” Gilliam says. “When someone hears ‘to-fund,’ they are probably going to assume it’s a more conservative approach because it’s not going to continue to roll down on equities over time. But that’s not always the case.”

Gilliam says it’s not uncommon to see a to-fund glide path land with 40% or 50% in equities—even if it’s designed to be held by retirees late into their life (see “An Argument for To-Retirement TDFs”). On the other hand, it’s also not unheard of to see TDFs that convert entirely or almost entirely to fixed income at the target date.  

“We just don’t agree with either outlook,” Gilliam says. “We know that investors' needs and expectations evolve and life continues to change after retirement. So you have to maintain a balanced approach that benefits the end investor on both longevity risk and investment risk, which is what we strive to do through the more sophisticated approach.”

Like others closely involved in TDF product development and delivery work, Gilliam predicts huge growth for the strategies in coming years and agrees with industry research showing as much as 50% of all 401(k) assets could be held in TDFs by 2020.

Part of making sure the trend is positive for retirement plan participants, Gilliam says, is building better and less costly TDF products.

“We expect that, regardless of how TDFs grow in the coming years, there will be big demand for advice and packaged solutions,” Gilliam says. “For a time we were swinging towards much more employee responsibility for retirement savings, but now I think you’ll see the pendulum is again swinging towards employer stewardship. These TDFs and packaged solutions can be a great middle ground.”

More information about the SMRT Funds is available at