The Defined Contribution Institutional Investment Association’s (DCIIA)’s Retirement Research Center has published a summary of key findings from its inaugural custom target-date fund (TDF) survey, primarily intended to aid defined contribution (DC) plan sponsors and asset allocators during custom glidepath discussions.
Chris Nikolich, head of glidepath strategies in the multi-asset solutions business at AB in New York City, and co-contributor to the research initiative, told PLANADVISER, “The whole purpose of this was to allow plan sponsors to compare their custom allocations to others managed by potentially other investment managers. That kind of peer information didn’t exist; there has been no ability for plan sponsors to gauge how similar or different their custom TDF glidepaths are to others.”
Joshua Dietch, another co-contributor and vice president and group manager for retirement financial education at T. Rowe Price, who is located in Owings Mills, Maryland, said plan sponsors also have no idea of the magnitude of their peer group—whether they are the only one with a certain glidepath or one of many. “With this report, plan fiduciaries know where they stand in a broader marketplace perspective,” he said.
The DCIIA survey template identified 29 asset classes, and more than a dozen additional asset classes were identified from an “Other, please specify,” option. The resulting 40-plus asset classes are categorized into four broad asset categories: equity, fixed income, inflation sensitive, and diversifiers.
Based on the DCIIA sample of those that provided both custom TDF and a breakdown of plan assets, custom TDF strategies accounted for 43% of total plan assets for the year-end 2017. On average, the number of individual funds, or vintages, per custom TDF was 10.
A majority of the average custom TDF exposure was allocated to equities and fixed income, with a relatively modest—but increasing—allocation to inflation sensitive assets 15 to 20 years prior to retirement. Diversifiers illustrate a relatively consistent, yet minor, average allocation.
Nikolich explained that diversifiers are used for what TDF fund managers are trying to do on behalf of participants—deliver growth in time and control risks. For example, when there are substantially rising interest rates, exposure to things other than traditional fixed income can help in that regard. He adds that “in today’s economic and capital market environment, most investment managers are not expecting the same returns we’ve seen over last 10 years—expectations for returns for both equities and bonds are lower. Diversifiers can help with return generation and growth control, and can be customized to the specifics of the plan.”
Custom TDF equity and fixed-income allocations
The research found high (95th percentile) equity allocations ranged from to 92% for 2060 funds to 39% for income funds. Similarly, the low (5th percentile) equity allocations ranged from 72% for 2060 funds to 12% for income funds. The average allocation to equities for 2060 funds was 85% falling to 28% for income funds. The spread between different custom TDFs was greatest for the 2025 and 2020 vintages, at 33 percentage points between the 95th and 5th percentiles.
The top five equity asset classes by prevalence were: U.S. large-cap equity (89%), non-US developed equity (69%), emerging markets equity (66%), U.S. small-cap equity (49%), and U.S. small- and mid-cap equity (29%). Every participating plan had allocations to U.S. all-cap, U.S. large-cap, or global equity.
On the low end of exposure, 5th percentile fixed-income allocations ranged from 32% for income funds to 5% for 2060 funds. The 95th percentile equity allocations ranged in a similar style, from 67% for income funds to 13% for 2060 funds. The average allocation to fixed income for income funds was 52%, declining to 7% for the 2060 fund. Differences between the 95th and 5th percentiles varied little for later-dated funds but peaked at thirty-five percentage points for the income allocation.
The top five fixed-income asset classes by prevalence were: core U.S. bond (94%, the highest percentage of any custom TDF underlying exposure), short duration bond (49%), high-yield/high-income bond (35%), cash (29%), and emerging markets bond (20%). Stable value was prevalent in 20% of custom TDF strategies. All plans had either core or global core allocations.
Future DCIIA research will delve further into comparisons of custom and off-the-shelf TDFs, but based on his experience, Nikolich said, regarding equity and fixed-income allocations, in general there is not a lot of differentiation between custom and off-the-shelf TDFs at the tail end of the glidepath for funds for younger and older participants. “There was more differentiation in the two or three vintages leading up to retirement, with higher growth strategies in custom TDFs, but we will delve more into this is the next iteration of the research,” he said.
Inflation-sensitive assets in custom TDFs
Unlike those for equity and fixed income, the 5th percentile allocations for inflation-sensitive assets were relatively consistent across vintages and showed little range around 4% to 6%. However, the range for the 95th percentile was more pronounced—from 46% for income funds to 14% for 2060 funds. The average allocation to inflation-sensitive assets for income and 2015 funds was approximately 18%, while vintages between 2040 and 2060 hovered around 6%. The custom TDF sample demonstrated consistency in inflation-sensitive exposure among later-dated funds designed for younger plan participants. However, as average allocations to inflation-sensitive asset classes rose, the spread between the 95th and 5th percentile allocations peaked for the retirement allocation fund at 41%.
The top five inflation-sensitive asset classes by prevalence are: TIPS bond (72%), real estate (48%), commodities (38%), real assets (23%), and global REITs (11%).
Nikolich said this was one of the biggest surprises for him in the research findings—the extent to which inflation exposures differed, especially as the analysis moved toward retirement and income funds. “This range could be very informative to plan sponsors,” he said.
Dietch said the findings about inflation-sensitive assets get to the heart of why plan sponsors may want custom TDFs. “They can better align instruments they want to use for different demographics, which off-the-shelf TDFs don’t allow for,” he explained.
Diversifiers in custom TDFs
Similar to inflation-sensitive asset classes, the 5th percentile allocations for diversifier assets were relatively consistent across vintages and showed little range around 1%. The allocations to diversifier assets were also consistent in the 95th percentile—between 17% and 20%—with the exception of income funds, which had a 95th percentile allocation of 30%. The average allocation to diversifiers was 2% across all vintages, but this percentage alone does not capture the high end of the allocations represented by the 95th percentile.
The top five diversifier asset classes by prevalence were: bank loans (6%), hedge funds (6%), global tactical asset allocation (GTAA) (5%), preferred (3%), and U.S. balanced (3%). Preferred refers to preferred stock (or preference shares), a hybrid security that combines some features of stocks and bonds. Preferred stock is still a stock and trades on an exchange, and it also pays a dividend, though it is generally higher than a similar common stock from the same company.
Nikolich said the research report bears out modest averages for inflation-sensitive and diversifier assets, and this is not right or wrong, but reflects different views from different managers.
Regarding the overall research findings, Dietch said he found it interesting that there is a lot of heterogeneity in terms of approaches by plan sponsors that, when mixed in the report, tends to get lost. “Each plan has unique rationales for doing what they did. The averages come together, but we could see a great range in what individual plan sponsors are doing,” he said. He pointed out that based on the feedback DCIIA is getting, there is enthusiasm to ask more questions. “We took a modest approach to get the research off ground with the intention that if it was successful, we can ask more complex, deeper questions to provide even more information to plan sponsors,” Dietch noted.
DCIIA says it seeks to expand its coverage of the custom TDF universe and incorporate other data elements. Future areas of research may include comparative glidepath analysis of “to” versus “through” strategies, corporate versus public DC plans, or “off-the-shelf” versus custom structures. DCIIA may also expand the scope of the project beyond custom TDFs to include other custom implementations such as balanced funds, managed accounts, and model portfolios.
Survey participants were asset allocation service providers for custom TDFs who submitted non-attributable plan statistics and asset allocation detail for custom TDF clients. The sample used for asset allocation statistics reflects 65 plans and 673 unique funds. The custom TDF assets represented in the sample exceed $340 billion, while plan assets exceed $990 billion. The total custom TDF market was an estimated $430 billion at year-end 2017, with the DCIIA sample accounting for roughly 80% of the total market.
The research report is available on DCIIA’s website.