The Appeal of an 8-Basis-Point TDF

The recent evolution of target-date funds (TDFs), like other investing programs popular with qualified retirement plan investors, has been a story of falling fees.

Fees have dropped across the retirement planning marketplace in recent years as new transparency regulations, along with a number of widely publicized fee-related litigation cases, helped focus plan sponsor attention on how expenses relate to fiduciary liability. Overall for this year, the estimated median plan fee for employers stands at 0.52%, or 52 cents for every $100 in retirement plan assets, according to a recent study from NEPC. This is down slightly from the 2013 findings, which estimated median plan fees at a record low 0.53%.

As NEPC explains, plan fees in this sense are a plan’s all-in costs, including fees related to investment management, recordkeeping and trust/custody services. These fees have continued to decline steadily in recent years amid regulatory changes and increased litigation, NEPC says. Strikingly, the weighted average of plans’ investment expense ratios also fell to 0.49% this year, compared with 0.52% in 2013 and 0.57% in 2006. These operating expenses are generally paid out of a fund’s assets and lower the return to a fund’s investors over time.

Jake Gilliam, managing director and portfolio manager at Charles Schwab Investment Management, says investment providers active in the retirement planning space are quite aware of the unfolding fee story. At Schwab, one particular point of emphasis is the qualified default investment alternative (QDIA), and the target-date funds that often serve as a plan’s QDIA. Sponsors received Department of Labor guidance in 2013 on TDF fee and benchmarking considerations, which directly tasked plan fiduciaries with thinking deeply about the competitiveness of their target-date fund investments—and whether the adoption of a nonproprietary approach would “be a better fit for your plan.”

Gilliam says Schwab first got into the target-date fund business in 2002, with its lineup of SMRT Funds—the Schwab Managed Retirement Trusts. The prepackaged investment products used a combination of active and passive management, Gilliam says, and were built in an open architecture, collective trust arrangement. The SMRT Fund series ranges from 35 basis points (bps) at the best institutional price up to 89 bps for smaller initial investments.

“We offered the SMRT Funds at a low cost point, but we saw that some plan sponsors just weren’t comfortable with active management in either their core lineup or in their target-date fund,” Gilliam observes. “They still liked open architecture, so that’s why we went ahead and launched the SIRT Fund lineup back in 2009.”

At the time, Schwab went with an 18-basis-point management fee, Gilliam says, putting the SIRT Funds—for Schwab Institutional Retirement Trusts—in very competitive fee territory. By comparison, he estimates the price for a broadly diversified Standard & Poor’s (S&P) 500 index portfolio at about 8 or 10 bps. The low price point for the SIRT Funds is achieved through the index-based management style and the collective trust structure, which is also appealing because collective trusts are only available to qualified retirement plans, he adds. This implies greater asset stickiness and allows the fund to operate more efficiently from a cash flow perspective, improving returns over time. 

“At the time, 18 basis points was very competitive and I believe we made some waves in the industry,” Gilliam says. “In the middle of last year, we made the move to cut that price point to 14 basis points, for the basic share class. Next was the recent announcement that we would make available another price point, at 8 basis points, through a share class that can be accessed with $100 million for the minimum investment.”

Gilliam predicts sponsors will be enthusiastic about the new price point, which he says is even more compelling because of the low initial price point. He is quick to point out, however, that fees are not the whole story when it comes to selecting a target-date provider.

“The plan sponsor, of course, should not just be buying a TDF because it happens to have a low price point,” he says. “It’s very much a fiduciary’s decision to buy these funds, and while price and fees are very important in that consideration, it’s also necessary to consider things like the five-year performance record, as well as diversification at the sub-adviser level and at the asset class level.”

He adds that sponsors should understand whether their target-date fund offering is “a fully diversified portfolio, including commodities, global REITs [real estate investment trusts], emerging markets and other alternatives that are becoming parts of successful retirement portfolios.”