Diverse TDFs Brought Diverse Returns in 2014

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.

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.