Leadership of Target Date Funds Continues: Competitive Pressures Emerge as Participant Needs Evolve

 

Increasing dominance of target date fund (TDF) assets by the largest U.S. provider, TDF asset rollouts around retirement, and several exits by some of the smaller TDF providers are some of the more notable findings of Mercer’s 2018 and 1Q 2019 research.

I have been researching target date strategies or their equivalents since the late 1990s, and one of my team’s roles at Mercer is to review the U.S. TDF market. We seek to do this comprehensively, from a number of vantage points:

  • We regularly conduct a proprietary survey that at last count covered 65 target date programs across 28 different managers;
  • We perform detailed research reviews and ratings, covering 97.1% of the TDF assets in our survey; and
  • We leverage our research by combining it with our broad interactions with market participants to identify and report on broad trends in the target date market.

With regard to the latter point, we recently released our Target Date Funds Highlights and Trends 2018 and Q1 2019 Update. While we usually look at TDF trends at the end of each calendar year, we extended our focus period through Q1 so that we could compare our survey of “off-the-shelf” TDFs with the results of the DCIIA Custom Target Date Fund (cTDF) Survey.

It has been amazing for me to see how the TDF market has grown and evolved, particularly since 2006 when the Pension Protection Act blessed the TDF as a Qualified Default Investment Alternative (QDIA) and provided a “safe harbor” for plan sponsors. Our latest findings illustrate how much the TDF landscape has changed.

Survey Highlights

  • Total U.S. TDF provider assets ended at $1.7 trillion in 2018, essentially flat on the year due to Q4 market gyrations. TDF assets increased to $1.9 trillion in Q1 2019 and grew to more than $2 trillion at the end of Q2 2019.
  • The largest TDF provider (Vanguard) had a 38% market share at the end of Q1 2019 (larger than the next three providers combined). In addition, the larger funds are becoming more alike in their asset allocation and glide-path policies; and the differentiated funds are increasingly struggling to attract assets, which is a bit sad.
  • While asset growth is strong in the target date space, there’s continued evidence that assets still roll out of TDFs when participants enter retirement, and some evidence suggests this could be happening earlier than retirement. While TDFs are attracting significant inflows in aggregate, DC plans in the U.S. are experiencing negative cash flows — highlighting a concerning trend for non-TDF DC investment products.
  • At the end of 2018, the total TDF market (including custom TDFs, or cTDFs) was estimated to be $2.1 trillion, around 27% of total U.S. DC assets. By now the total TDF market must be in excess of $2.5 trillion! The off-the-shelf TDF market is estimated to be around four times the size of the cTDF market.
  • Fees are a perennial focus of DC plan sponsors, and fee compression has continued unabated — even among passive providers. Admittedly, the reduction in average fees was largely due to the addition of new share classes, but the new data was surprising. At the same time, we are seeing renewed focus from active providers to develop and bring new hybrid series (that is, those that combine active and passive strategies) to market.
  • For the first time, our team compared the composition and glide paths of custom TDFs with off-the-shelf TDFs. On average, allocations looked fairly similar. Perhaps this confirms that the reasons why plan sponsors consider cTDF strategies may be much to do with leveraging existing asset manager relationships and being able to retain greater control over the strategies. However, there were a few outliers in the cTDF market that offer more extreme or more clearly differentiated allocations.

What Can Disrupt the TDF Market?

Morningstar recently analyzed the persistency of default options and concluded that “participants who accept the default tend to be younger and have lower plan tenures, lower incomes, lower plan balances, and lower savings rates.”[1] Given the observation that TDFs are often used by less engaged participants (by default), and by participants who potentially may be more financially vulnerable, plan sponsors should ensure they are continually reviewing and documenting their TDF selection and monitoring processes.

Following the due diligence tips the U.S. Department of Labor (DOL) issued in February 2013 is a good place to start. Several recent court cases directed at target date strategies reinforce the importance of continually evaluating the suitability of a Plan’s target date selection.

Looking forward, one wonders whether the target date market can continue to display such dominance within the retirement plan industry. To be sure, there have been some big winners, but others struggle to compete. This year alone, we know of at least three TDF providers that have found it challenging to attract assets and no longer offer TDF series. A fourth provider closed its more expensive TDF series and now offers only a hybrid version.

Two issues that could cause significant disruption within the TDF space are the increasing desire for more personalized solutions — a need that TDFs structurally do not address, and the growing interest in retirement income solutions. Guaranteed retirement income features have not found a foothold in the manufacturing end of the target date market, but we are seeing increasing interest from plan sponsors to at least discuss such options. Whether discussions lead to action, only time will tell.

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David Blanchett and Daniel Bruns, “Which Default Investment is the Stickiest?” Morningstar Investment Research LLC.

Mercer does not provide tax or legal advice. You should contact your tax advisor, accountant, and/or attorney before making any decisions with tax or legal implications. This does not contain investment advice relating to your particular circumstances. No investment decision should be made based on this information without first obtaining appropriate professional advice and considering your circumstances.