TDFs: Set, But Not Forgotten

TDFs may be ‘set it and forget it’ investment vehicles, but they continue to evolve to meet plan sponsor needs of low-cost options and further customization.

Target-date funds have become the most popular retirement savings vehicle in employer-sponsored retirement plans. As of the end of 2022, 85% of 401(k) plans included TDFs in their investment lineups, according to the Employee Benefit Research Institute.

As these funds have grown in popularity, their managers have had to navigate an ever-changing landscape of plan sponsors who want to ensure their participants grow their wealth through retirement without facing exorbitant fees. To keep up, plan providers are revamping their approach to active and passive funds, developing more refined glide paths, offering additional customization, personalization and more. Here, we look at the recent evolution of TDFs and what to expect in the years to come.

Never miss a story — sign up for PLANADVISER newsletters to keep up on the latest retirement plan adviser news.

Shift in Underlying Investments, Vehicles

There have been two significant trends of late for lower-cost defined contribution plan investment products, says Chris Brown, founder of and principal in Sway Research: the shift from active underlying investments to passive ones and the shift from mutual funds to collective investment trusts.

Passively managed investment products in DC plans have been widening their lead on actively managed products, as investors seek lower-cost options. Meanwhile, many of the largest providers have reacted with blended active and passive products.

American Funds—the firm Sway says controls the bulk of the active market alongside T. Rowe Price, which launched its first blend solution just six years ago—introduced its first active/passive TDF in early September. The move was about giving plan sponsors more choice, says Michelle Black, a solutions portfolio manager at Capital Group.

“They might place different weights on the trade-off between fees and the opportunity for excess returns in their decisionmaking criteria,” Black says. “We think we’re meeting that need by offering a blended target-date strategy as a complement to our all-active series.”

Sponsors are also looking for more options when it comes to the vehicles in which these investments are held. Just recently, CITs overtook mutual funds to become the largest holder of TDF assets, according to data from Sway Research. Capital Group recognizes this trend: The firm introduced its all-active CIT in 2019 and is also offering its recently launched TDF blend product in a CIT.

More Tactical Approaches to Glide Paths

There has also been a transition toward more tactical glide paths, as opposed to predetermined ones, as firms give themselves some leeway to adapt to market conditions, Sway says.

BlackRock has shifted away from more traditional stock-and-bond portfolios to implement more precise glide paths, says Nick Nefouse, global head of LifePath and head of retirement solutions at BlackRock.

“We’re adding more precision because our view is we have to be forward-looking in markets,” Nefouse says. “What worked in the last 10 or 15 years, it’s not clear to me that that’s going to work in the next 10 to 15 years.”

For example, the firm’s LifePath Dynamic, which aims to provide retirement outcomes based on quantitatively measured risk, “takes advantage of volatility,” he added.

While T. Rowe Price’s strategic design is built on long-term expectations, the firm also incorporates a tactical approach to its funds—an attractive quality for many investors during the transition to a lower-interest-rate environment.

“The portfolios are not ‘set-it-and-forget-it,’” says Kim Dedominicis, a portfolio manager of the target date strategies in T. Rowe Price’s multi-asset division. “They’re going to be able to incorporate those tactical views based on that six-to-18-month time horizon.”

Retirement Income

Another trend likely to continue is guaranteed income in TDFs, Sway says.

“The trick is how to keep it from driving costs through the roof and keeping it portable so if people leave the plan and go somewhere else, they can still maintain that income guarantee,” Sway says.

Brian Miller, a senior investment specialist and head of TDF product management at Vanguard, says that while industry personnel have been looking for a “silver bullet” to address the need for retirement income, they seems to finally be coming around to the fact that there likely is not one single product or solution that will do so.

Vanguard approaches retirement income as a spectrum of different products and solutions that can meet investors where they are: For some investors, that’s advice, and for others, there are systematic withdrawal tools so they can create a consistent paycheck from their accounts, or they can get access to annuity platforms. The firm is also researching the possibility of incorporating annuities into TDFs, a move others in the industry, such as BlackRock,have made, Miller said.

Customization and Personalization

In the DC market, there has been a high contribution of assets in mega-plans as companies merge, Sway says. A plan made up of $1 billion that 10 years ago was four different companies with an average of $200 million has more opportunity to ask for products customized to its specific workforce—based on age, income, education or a different variable.

Vanguard continues to consider further customizations to its series, Miller says. For example, the firm recently launched an additional opt-in landing point for its glide path that contains a slightly higher equity allocation.

“That was really a recognition that investors in a plan usually have a pretty wide range of different needs and circumstances,” Miller adds. “We wanted to have plan participants—and plans in general—have the ability to have two different landing points, depending on those individual needs.”

Personalization is picking up speed as well. T. Rowe Price recently launched Personalized Retirement Manager, which provides a fully personalized glide path for each participant. The product is based on its TDF asset allocation methodology and offers participants the ability to engage as little or as much as they would like (the more they engage, the more personalization).

That need for engagement is a challenge most in the industry face when it comes to personalized products, according to Miller at Vanguard.

“Until we really start to get to a point where we have participants who are willing to provide information and engage with their investments, it’s going to be hard to truly have a personalized TDF that is prevalent across an entire plan,” he says.

Sway predicts that personalized products will continue coming to market, but their success will come down to cost.

“If it’s expensive, then it probably won’t fly,” he says.

CIT Growth Continues With Adviser Backing

As more plan sponsors turn to collective investment trusts to reduce costs, industry experts see both opportunities and challenges.

In recent years, there has been a noticeable shift in the retirement plan industry, as more plan sponsors incorporate collective investment trusts into their investment offerings. Although CITs have existed for decades, their adoption is accelerating, particularly as cost-conscious plan sponsors seek alternatives to traditional mutual funds.

Industry experts note that the cost-saving potential of CITs, along with their growing availability and ease of use, are driving this trend. Chuck Williams, managing partner in and CEO of Finspire LLC, highlights that CITs, once primarily available to larger retirement plans, are now more common across a range of sizes.

For more stories like this, sign up for the PLANADVISERdash daily newsletter.

“70% of our clients will have some CIT in there,” he says. “A couple of years ago, it was mostly larger [plans], but now we’re seeing smaller plans incorporating them as well.”

Jessica Ballin, an investment adviser representative and principal in 401k Plan Professionals, echoes these sentiments, stating that CITs are now discussed across the board. Ballin explains that some CITs offer as much as 30% in cost savings, compared with mutual funds, making them an attractive option for plan sponsors looking to minimize expenses without sacrificing performance.

“There’s always some funds that we love and use on a regular basis, and they screen very well,” she says. “If a CIT offers a 30% cost savings, it makes sense to utilize it.”

Challenges to Adoption

Michael Gheen, vice president and director of retirement plan services at Oswald Financial Inc., further emphasizes the importance of cost structure when evaluating CITs.

“Depending on the plan size, CITs can be [at least] five basis points … less expensive than mutual funds,” Gheen notes. “We will definitely bring that to the committee’s attention and have a discussion around it.”

However, he also acknowledges that the decision to switch to a CIT from a mutual fund is not always straightforward. He might not use a CIT structure or entertain the idea if the cost savings are minimal, for example, citing situations in which savings might only be 2 to 3%, not warranting a change.

Despite the advantages CITs offer, one challenge in broader adoption is educating plan sponsors about how CITs work, Gheen adds. Mutual funds are a familiar product for most sponsors, but CITs are less known outside of the financial industry, despite their similarities to mutual funds in terms of structure and operation.

“Especially in the smaller end of the market, plan sponsors don’t understand what CITs are,” Gheen says. “It’s a real learning curve.”

Williams adds that part of the responsibility lies with advisers and plan sponsors to broaden their conversations with clients about investment options. Many plan sponsors are already having these conversations, and CITs should be included alongside stable value and money market funds to ensure plan participants are aware of all options available to them.

Opportunities and Obstacles

One of the barriers to CIT adoption in the past has been the administrative complexity required. However, Gheen notes that over the past few years, these processes have become much more efficient, reducing the burden on plan sponsors. As the administrative burden has lessened, the opportunities to incorporate CITs have continued to grow. Ballin points out that even in the last two years, the availability of CITs has expanded significantly.

But even as the CIT market is expanding, the future of retirement plan regulations and the potential for legislative changes remain uncertain. Gary Gensler, chairman of the Securities and Exchange Commission, has mentioned the potential for heightened regulation of CITs, which are currently overseen by the Office of the Comptroller of the Currency.

In a PLANADVISER webinar held on September 24, Tom Demko, managing director at SageView Advisory Group, said he is more worried about the increasing threat of plan litigation than about scrutiny from regulators.

In recent years, certain law firms have been filing what Demko describes as “cut and paste” lawsuits, often based on allegations that improper fees were charged by recordkeepers or investors were in the wrong share class.

Demko believes this trend will continue: “As CITs become more and more prevalent, they’re going to, of course, attract more of that kind of litigation.”

«

 

You’re viewing the first of three free articles.

 Subscribe to a free PW Newsletter! 

…subscribing gets you free access to PW’s online content!

If you’re a subscriber, please login.

Close