TDF Market Shows Signs of Maturity

An increase in the number of TDF providers has been a positive development for investors, as it has led to lower fees and more product choices, according to Mercer research. 

The March 2017 Target-Date Trends report from Mercer highlights evidence of a robust and evolving target-date fund (TDF) market, with total assets invested reaching $1.29 trillion in the fourth quarter of 2016.

This is up from $1.03 trillion in in the fourth quarter of 2015, according to Mercer’s findings. The asset growth has been supported by “strong participant-directed cash inflows, with TDFs now being the default investment option (QDIA) in many defined contribution (DC) plans, and also by strong absolute performance.”

Interestingly, Mercer reports the largest four providers of TDFs have continued to maintain their dominance in terms of assets under management, “although their market share has declined from 82% in the fourth quarter of 2011 to 75% in at the end of 2016.”  Their relative positions have changed, however, “with the largest TDF provider [Vanguard] now having approximately one-third of all the assets surveyed.” Fidelity and T. Rowe Price round out the top three. 

The majority of TDF providers continue to construct their TDF portfolios using proprietary funds as the underlying investments, Mercer finds, “despite reports of plan sponsor unbundling trends.”

According to Mercer, in aggregate, across providers and funds, all vintage years between 2060 and 2020 experienced an increase in total assets during 2016. In contrast, vintage year funds that had passed their target years experienced a decrease in total AUM—as would be expected.

“This is not a significant surprise,” Mercer researchers agree, “and although a variety of reasons can be proposed, we are confident the key reason is individuals rolling their assets out of their DC plans at or around retirement. It will be interesting to see whether this trend changes given that more plans are encouraging retirees to stay in the plan.”

NEXT: Plan sponsors seek top TDFs

The Mercer research argues that, clearly, all TDFs are not created equal. Recent variations in returns, “while far less dramatic than was experienced in the global financial crisis,” can still add up.

“This reinforces why plan sponsors should review their TDF’s relative performance and be sure they understand the reasons for outperformance or underperformance,” Mercer suggests. “Some of these reasons could include glide path and roll-down structure; differing strategic asset allocations; use of dynamic or tactical asset allocations; and ‘alpha’ from active management.”

Researchers share the following example to highlight the critical importance of considering relative performance and fee structures: “If we focus on the 2030 vintage (which is the vintage with the largest AUM), $1,000 would have accumulated to $1,302 over five years with the 5th percentile outcome, whereas with the 95th percentile outcome the $1,000 would have accumulated to $1,619—that is a meaningful difference.”

The report concludes that there has been a move toward passive TDFs—with the main driving factor being the desire of plan sponsors to have lower fees. But as of the fourth quarter of 2016, active manager fees have reduced; median fees across vintage years for actively managed TDFs ranged from approximately 0.45% to 0.60% versus approximately 0.10% for passive funds.

“Between the fourth quarter of 2015 and the same quarter in 2016 the median fee for passive TDFs decreased by one basis point, which is material relative to the already low fees for this space,” Mercer concludes. “This fee reduction may be attributable to the launch of several low-cost products disrupting the passive TDF space (and price being a key discriminating factor when evaluating a passive TDF provider).”