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New Mix of Target-Date Funds, Same Old Problems

By Murray Coleman December 13, 2017

Target-date retirement funds keep attracting billions of dollars in new money each year. But as investors put more of their savings into such automated asset allocation tools, advisors can find themselves in a rather awkward position.

On the one hand, target-date funds are a popular investment option in workplace retirement plans. Market researcher Callan estimates 88.1% of 401(k) plan sponsors last year used TDFs as their default options. Nearly all U.S. plans (93%) offered some sort of TDF choices.

“Putting money into a low-cost target-date fund is certainly better than doing nothing,” says Tim Maurer, head of personal finance at St. Louis-based Buckingham Strategic Wealth, which manages about $13 billion.

Besides offering a basic level of diversification across different asset classes, such funds automatically shift allocations to coincide with retirement dates. The closer someone gets to leaving the workforce, asset weightings to riskier parts of the market will typically be lowered.

“That’s at least something of a benefit for people who otherwise might just not want to deal with asset allocation issues and wind up putting all of their retirement savings into cash,” Maurer says.

But critics argue that funds claiming to do most of the heavy lifting tend to feed poor investment behavior and don't help build a proper perspective of how markets work.

Indeed, just 13% of 401(k) plan participants surveyed last year by recordkeeper Alight Solutions professed to realize that TDFs are designed to automatically rebalance their assets over time. When asked how much they understood about such investment products, 68% of plan participants characterized themselves as “not knowing anything” about TDFs.

“There seems to be a lot of misunderstanding about what investors think target-date funds do and what they actually are designed to achieve,” says Alight analyst Rob Austin.

Meanwhile, TDF assets – mainly through retirement plan platforms – entering December had spiraled to nearly $1.07 trillion, according to Morningstar. That’s a rise of 174% from 2012 for a market being led by Vanguard, Fidelity and T. Rowe Price.

At the same time, the Chicago-based investment researcher estimates 2017 net money inflow into these types of mutual funds and ETFs surpassed $60 billion through November.

“As their popularity continues to increase, so does the need for more discussion with investment professionals about whether ETFs are really a good fit for each unique situation,” Austin says.

It’s a tack Brion Collins says he’s increasingly taking these days. The Delafield, Wisc.-based advisor at Bronfman Rothschild figures a third of the firm’s business comes from working with defined contribution plans. The independent RIA, which oversees about $5.8 billion, says it does recommend TDFs in certain cases to 401(k) plan sponsors.

But when retail investors come to see him about their personal financial needs, Collins notes he “rarely” suggests TDFs. “We believe that a disciplined asset allocation strategy with full transparency and a greater degree of flexibility can lead to better long-term investment success for our clients,” he says.

TDFs typically operate as fund-of-funds, which Collins sees as translating into “advisors not always being able to take a comprehensive look underneath the hood” of the underlying holdings. Bundling of funds can also increase costs and create more transparency headaches, he adds.

Brion Collins

“By its very nature, talking to an advisor should interject a certain level of skepticism and a greater degree of thoughtfulness into the asset allocation process,” Collins says. “That conversation should lead to less of a cookie-cutter approach to finding the most appropriate investments for each individual client.”

Buckingham advisor Maurer agrees. A key talking point he likes to raise with new clients is that TDFs aren’t identical. So-called glide paths, which set rebalancing guidelines, can vary quite dramatically. “It’s important to help educate people how differently target-date retirement funds can act over time,” he says.

Although once a marketplace chock-full of index-based funds, Maurer finds that actively-managed TDFs are now plentiful. And that can make portfolios more difficult to track, he adds.

"You’re also driving up fees and internal costs by owning actively managed target-date funds," Maurer says.

Somewhere in-between is a growing class of smart-beta TDFs. These funds are designed to take into consideration other factors than just a person's retirement age. That can include anything from stock styles and valuation ratios to market-cap sizes and quality of earnings metrics. Typically, such smart-beta funds feature lower fee structures than active TDFs.

But Maurer is concerned that not enough research is available yet for such a nascent category. While seeing a case for advisors to expose client portfolios to a wider range of market measures that might influence returns, he remains skeptical that including more performance-related factors into TDFs will prove beneficial over time.

More than 200 different factors have been identified by academics, Maurer observes. “Putting more factors into target-date funds can add complexity to a product that’s supposed to simplify investing,” he says. “Inside a target-date wrapper, smart-beta seems more like savvy marketing than anything of sufficient substance to warrant serious consideration.”