Surging TDF Market Sees Product Innovation

With TDFs growing rapidly in the DC market, providers are exploring new ways to stand out from the crowd.

There’s no doubt about it: Target-date funds are a driving force in the defined contribution (DC) space, and the forward momentum does not seem to be stopping anytime soon. But changing investor preferences and market trends are pushing providers to reexamine the mechanics of the TDF to find new ways to stand out from the pack.

“Target-date funds have been on a remarkable growth trajectory, with assets climbing from roughly $125 billion 10 years ago to nearly $900 billion recently,” explains Jeff Holt, associate director of multi-asset strategies research at Morningstar. “What’s more, these funds have become the main source of new asset flows to many firms, accentuating their importance. Meanwhile, target-date investors have increasingly demanded low-cost options, which has affected how target-date providers approach their funds and has caused many to branch out with additional offerings.”

Morningstar finds that by the end of 2016, the average asset-weighted expense ratio for TDFs was .71% compared to .99% in 2011.

Moreover, the firm found that 12 firms offered more than one target-date series at the end of 2016 in an attempt to cater to different investor preferences. Ten years ago, no firm offered more than one series. These are some of the many trends shaping TDF evolution.

And today, the TDF market sows signs of maturity. Providers still ponder thoughts about active and passive management, open and closed architecture, traditional and alternative investments, to or through glide paths, and more. 

But Morningstar reports that “equity allocation generally determines how well a series’ results will compare with those of its peers, more so than broad distinctions such as active versus passive or open versus closed architecture. On average, each percentage point of additional exposure to equities added 6 basis points to funds’ returns.”

Moreover, the firm found that two out of every three dollars investing in TDFs went to a series investing mostly in index funds, which tend to keep fees low.

“Everything equal, lower fees indeed provide a discernible advantage, but we’ve found that even similarly priced target-date funds can differ in potentially meaningful ways,” Holt says. “In fact, target-date funds generally look the most different from one another at the retirement date, when their results matter the most.”

NEXT: TDF Market Trends

Holt says, “Over the past couple of years, target-date series that invest exclusively in index funds have seen more flows than those that use actively managed underlying funds. As a result, the market share of active and passive series has converged.

“At the end of 2006, active series held 83% of target-date mutual fund assets, but by end of 2016 they only accounted for 61% of assets. While active series still hold the lead, passive series are poised to keep closing the gap unless the prevailing trend with flows reverses.”

Morningstar points out that TDFs showed a positive 1.4% point investor return gap in the 10-year period through 2016, “showing that investors have reaped benefits from making steady contributions to the funds.”

The three dominant players in terms of size in the TDF market remain Vanguard, Fidelity and T. Rowe Price, which together account for more than 70% of TDF assets. However, Vanguard was the only firm to boost its market share in 2016 with $37 billion in net inflows that year.

Morningstar also tracked net outflows. Three of the 10 largest TDF managers saw net outflows in 2016, Morningstar reports. “Fidelity's target-date series had $3 billion in outflows in that year. Principal and John Hancock had net outflows of $500 million and $240 million, respectively, in 2016."

These findings are from Morningstar’s Ninth Annual Target-Date Fund Landscape Report. The research report is available here. Additional articles and videos will be available on in the coming weeks.