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3 Key Developments in the Target-Date Landscape

Our 2021 paper reveals new trends.

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. Morningstar recently published its annual target-date landscape report for 2021. Joining me today to talk about three key trends from that report is Jason Kephart. Jason is one of the paper's lead authors, and he's also strategist with Morningstar's Multi-Asset Team.

Hi, Jason, thank you for being here today.

Jason Kephart: Thanks for having me.

Dziubinski: One of the trends that you've observed is what we're calling "the rise of collective investment trusts," or CITs, and target-date assets in CITs crossed $1 trillion mark in 2020. So, tell me a little bit about that growth rate, what it's looked like, and what percentage of target-date assets are in CITs versus mutual funds today?

Kephart: Sure. We estimate that at the end of 2020, about 42% of target-date assets were in CITs. That's almost double what it was just five years ago. So, clearly, we're seeing a lot of growth there. And one of the reasons for that is CITs are much more popular among the largest 401(k) plans, so the contribution there is naturally going to be larger.

 What are some of the advantages that CITs might have over mutual funds?

Kephart: There's one key advantage. Now, imagine we're both defined-contribution plans. You have $10 billion. I have $1 billion. If we both pick the cheapest share class of, say, BlackRock LifePath Dynamic, under the Investment Act of 1940, we're both required to pay 40 basis points, despite our differences in asset levels. Now, in a CIT, that is not a requirement. So, you can actually negotiate lower fees. So, with your $10 billion in assets, you might be able to get 35 basis points instead of 40. And you know, 5 basis points might not seem like a lot, but in a $10 billion plan, that's $5 million you just saved for your participants. So, from a fiduciary standpoint, it always makes sense for a plan sponsor to at least kick the tires and see if they can use their assets to get better fees for their clients.

Dziubinski: Now, another trend that you talk a bit about in the report is this idea of falling fees and falling investment minimums. Let's talk about fees first. What have we seen this year when it comes to fees?

Kephart: It's no secret that fees are a really critical role in target-date funds. We've seen that it's been a long-term trend that the cheapest target-date funds have tended to collect the most assets. We saw that trend continue in 2020. Although overall flows were down in 2020 in the target dates because of all the economic stress caused by the pandemic, we still saw 90% of net inflows go to share classes in the cheapest decile. Investors are really choosing just the lowest-cost target-date series, and we think that, over the long term, lower fees are going to lead to better outcomes. So, this is, in our view, a very positive development.

Dziubinski: Now, both Vanguard and Fidelity have lowered the investment minimums on their cheapest share classes. What impact do you expect that to have on the average fees that target-date investors pay?

Kephart: It should just drive them lower. When you're a Vanguard and Fidelity, and there we're talking about the cheaper share classes, around 9 or 10 basis points, there's really only so much room you can cut before you're getting to zero. They're kind of getting close to that threshold on how low fees can actually go. So, the next way to compete on fees, it just makes those cheaper share classes more accessible to more people, which again is a big win for investors.

Dziubinski: Now, as target-date investors have continued to gravitate more toward those lower-cost options, are we still seeing that fees are a predictor of outperformance?

Kephart: We still are seeing that. We looked at how the cheapest target-date funds have done versus those in the middle of the pack. What we found is they are continuing to outperform. And there's always going to be exceptions. You're always going to have an American Funds or a T. Rowe that is very stellar and can overcome its fee hurdles, but in general, starting with fees as a starting point should lead to better results over the long term.

Dziubinski: And lastly, let's talk a little bit about different types of investments that are now available to target-date series. Regulators are now allowing target-date investments to purchase alternatives, some alternatives, like private equity. Have we seen any uptake of that yet?

Kephart: We haven't seen any uptick of private equity yet. I think there are some operational challenges firms are going to have to think through in order to make that a viable part of a target-date strategy. Things like capacity: Private equity is a very capacity-constrained vehicle, and a lot of these target-date funds are very big. So being able to find a private equity fund that could handle enough assets to still make a difference in the target-date fund--that's something I think the firms are going to have to work out. So, we haven't seen much there yet. But we have seen private real estate already does play a role in at least one target-date mutual fund series, TIAA Lifecycle, and it's more popular in collective investment trusts. So, there are already these illiquid investments starting to make their way into target-date funds.

Dziubinski: Well, Jason, thank you very much for your time today, giving us a "lay of the land-scape" of target-date series today. We appreciate it.

Kephart: Thanks for having me.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thank you for tuning in.