Diverse TDFs Brought Diverse Returns in 2014

New Morningstar research shows what you expect is not always what you get with target-date funds.

True or false: a given asset manager’s 2050 target-date fund will outperform its 2045 counterpart during a year of strong market growth and manageable volatility.

The intuitive answer is “true,” given the nature of glide-path investing and that the whole point of target-date funds (TDFs) is to automatically ramp down on portfolio equity exposure over time—limiting both market risk and growth potential as the investor approaches the anticipated retirement date. In practice things are somewhat murkier, observes Morningstar’s “2015 Target-date Fund Landscape” report.

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Asset managers deployed a diverse mix of target-date fund philosophies during 2014, the Morningstar research shows, resulting in a wide range of returns for the year. In an unexpected turn, some series’ shorter-dated funds even outpaced their longer-dated siblings, reflecting differences in asset allocation and underlying fund composition, researchers observe.

Assessing target-date fund performance is a challenging exercise for even the most experienced retirement plan officials, Morningstar explains. Understanding each TDF series’ quirks and position in the broader target-date fund landscape can help investors set expectations in a more informed way. (See “Examining Risk Management in TDFs.”)  It’s also an important part of the fiduciary duty, which the Department of Labor highlighted in an informal 2013 guidance publication, often referred to as the DOL’s “TDF Tips.”

Insights about how to compare TDFs are growing ever-more important, Morningstar says, because a greater number of savers are using the funds for longer portions of their investing lifecycles.

At a high level sponsors reported being satisfied with TDF returns during 2014. In aggregate, target-date funds in the Morningstar database showed asset-weighted average investor returns (which take fund flows into account to estimate a typical investor’s experience in a fund) are 1.1 percentage points higher than the funds’ average total returns, “suggesting that, on average, target-date fund investors are using the funds effectively.”

Morningstar finds growth of target-date mutual funds has slowed somewhat, “but the funds remain key conduits to their fund companies’ other funds.” On average, target-date funds accounted for more than 30% of the net new inflows to their respective fund firms in 2014. All told, Morningstar finds TDFs made up approximately 8% of these firms’ total mutual fund assets, as of December 2014. 

Total target-date mutual fund assets grew to $706 billion by December 31, 2014, Morningstar explains. This means investors pumped $49 billion in net new assets into the funds last year, representing an 8% organic growth rate. Taken together, Fidelity, Vanguard and T. Rowe Price account for an impressive 71% of the asset management industry’s target-date fund assets.

“Rising markets brought gains to every target-date fund in 2014,” Morningstar notes, “though more-diversified series—particularly ones with an international bent—tended to fall behind their peers.”

Index-based target-date series showed a performance edge over their actively managed peers in 2014 and the past decade, Morningstar says. This reflects a fee advantage and, in some cases, above-average exposure to U.S. stocks, which outperformed most other asset classes last year.

In another positive sign for end investors, the average TDF user paid lower fees for the sixth year in a row, Morningstar says. Specifically, the asset-weighted expense ratio of target-date funds fell to 0.78% in 2014 from 0.84% the year prior.

The industry average asset-allocation glide path’s stake in equities ticked up by as much as 4% in 2014 compared with the year prior, Morningstar adds. “Portfolios generally display a significant home-country bias, though within their international stock stakes they’ve fully embraced emerging-markets stocks,” the report continues. “Alternative investments have become increasingly common in target-date funds, with non-traditional bond and multi-alternative categories garnering the most attention from managers.”

In one clear area of bifracation for TDF approaches, Morningstar finds more than half of the industry’s TDF series have no manager self-investments in the series’ target-date mutual fund vehicle. “Only three managers devote more than $1 million of their personal assets to the mutual funds of the series they manage,” researchers note.

The full 2014 TDF performance report can be downloaded here. Name, email address and firm info is required. 

Global DC Plans Highlight Efficiency Trend

A survey of Vanguard retirement plan clients operating in three or more countries shows, like in the U.S., the DC conversation globally is centered on fees, effectiveness and efficiency.

A new report from Vanguard shows the majority of its global retirement plan clients—some 90 companies holding $650 billion in plan assets across three or more countries—have taken steps recently to streamline and centralize retirement plan administration.

The main reasons given for this trend towards centralization and simplification were policy/organizational efficiency and risk management. As noted by Vanguard, respondents were clear that full centralization remains an elusive and likely unattainable goal, given local market rules and regulations that can vary both within and among countries. Vanguard says even companies operating in just one country have to keep abreast of an impressive amount of benefits and investing law—and going international brings a significant set of challenges.  

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Interestingly, both small and large international organizations are exploring opportunities around greater centralization of benefits and HR administration. Large organizations appear the most energized and engaged in the conversation, however, in part due to their ability to create greater economies of scale.

Some trends appear to be playing out the same internationally as in the U.S., including the sweeping transition from a predominantly defined benefit (DB) to a predominantly defined contribution (DC) approach to retirement benefits. International plan sponsors seem to be even harder pressed to find sufficient time and resources to manage legacy DB offerings while ensuring newer DC plans offer enough value for participants.

On average, 58% of international sponsors’ time, resources and effort is spent on DB plans, Vanguard says, compared with 38% on DC plans. In a sign that the U.S. is perhaps ahead of the long-term trend, the figure for time spent on DB plans rose to 71% for non-U.S. headquartered respondents.

Vanguard researchers conclude DB plans will continue to consume significant resources for both U.S. and international sponsors, while support for DC plans will also need to grow as their popularity grows among workers.

“Something will need to give,” the report continues. “Either resources and costs will need to increase, or plan sponsors will need to find ways to simplify the structure and approach to their global retirement plans.”

Vanguard finds liability-driven investing (LDI) is a popular theme both in the U.S. and abroad, as sponsors focus more on smoothing and controlling return streams than on maximizing risk and returns. Of the various implementation methods explored for LDI, a glide-path approach was the most popular. When awarding investment mandates—especially passive investing mandates—fees and tracking error were considered the most important factors in assessing managers and investment funds. Net costs are a significant consideration, Vanguard says, when sponsors are deciding on an active manager, but the investment strategy and manager experience/performance record are more important.

When asked how they expected the level of company contributions to DC plans to change in the next five years, 57% of international sponsors said they anticipate a moderate increase, while 14% will increase their contributions dramatically. Vanguard concludes that an increased attitude of shared responsibility for DC plan outcomes among plan sponsors, in the U.S. and globally, will drive funding approach changes in the years ahead.

The full survey summary can be downloaded here

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