What's Propelling Target-Date Popularity?
401(k) auto-enrollment and auto-escalation recently helped to propel target-date funds--the default choice in many plans--to record inflows.
401(k) auto-enrollment and auto-escalation recently helped to propel target-date funds--the default choice in many plans--to record inflows.
Adam Zoll: For Morningstar, I'm Adam Zoll.
Target-date funds are becoming an increasingly popular investment option for those saving for retirement.
Here to talk about trends in target-date funds is Jeremy Stempien, director of investments from Morningstar Investment Management.
Jeremy, thanks for being here.
Jeremy Stempien: Thanks for having me, Adam.
Zoll: Your team just put out its quarterly report on target-date funds, and among the interesting findings was that there were record inflows to target-date funds in the first quarter of 2013. What were the findings and why do you suppose there were these record inflows?
Stempien: We did see inflows at an all-time high for the quarter. I think there's probably a number of reasons we saw them, maybe the most obvious being that target-date funds continue to be the predominant winner in the QDIA [Qualified Default Investment Alternative] race among plan sponsors, meaning plan sponsors or companies are designating target-maturity funds as the default for their employees. So we continue to see increased usage among employees, and target-date fund assets have continued to trend upward.
In addition to that common theme, I think we typically tend to see a bump during the first quarter of the year, and that's due to probably a number of factors: one being the 402(g) limit, so the contribution limit for participants. Some participants hit that limit throughout the year, and they stop contributing. At the beginning of the following year, they start contributing again. So you see some of those people come back into those contribution or those asset numbers. Also a lot of companies may pay out a bonus, and part of that bonus may go into target-maturity funds during the first quarter. So I think it's not uncommon to see those sorts of things really affect the flow numbers.
Then there are other factors, like increased services by plans, like auto-escalation, so rates may be kicked up a little bit during the first quarter. Continuing just to default people in at higher rates in general continues to contribute to that flow number generally rising over time, but particularly in the first quarter we saw great flows.
Then top that off at the end of the day with consumer confidence being at a high for employees. The markets had a nice little run. That encourages people, they tend to want to contribute more, [and] get back into contributing in their 401(k) plan.
<TRANSCRIPT>
Zoll: Also some increased inflows especially for younger investors.
Stempien: That's right. A lot of the older employees for companies, maybe when they joined, they weren't defaulted in, so they would have to actively elect to get into the target-date funds, whereas younger employees are the ones that really tend to be defaulted in.
So although the bulk of the assets tend to be with that middle-aged crowd, because they have larger plan balances, the bulk of the flows or a high percentage of those flows are coming from the younger investors, as they are the larger percentage of the people actually invested in target-date funds.
Zoll: Another interesting finding in your report is that many target-date funds tend to lag Morningstar's Lifetime Allocation Indexes. I imagine one of the reasons for this is that the funds have to charge fees, which would create a lag, but are there other factors at play?
Stempien: It's a great question, and I think you hit the nail on the head: Probably the number-one reason you're going to see difference in performance, and maybe the most obvious, is a fee impact. Target-date funds typically charge fees. I think the average fee for the retail target-maturity fund is around 90 basis points, and there are no fees associated with the index. So that's going to cause a difference in performance.
Now we've looked outside of that, though, after we account for a fee impact, [to understand] how have the [indexes] done, and we've seen they've still held up very, very strong relative to the retail universe. I think the main reason for that is the indexes are actually built [to be] very diversified, so we use 18 unique asset classes, which is more than probably your typical target-date fund or most of the target-date funds actually use, and by aggregately using all those different asset classes, the result is, we hope that over the long term the performance holds up very well, and that's what we've seen thus far since we released them.
Zoll: Let's turn now and talk about something called "Glide Path Stability." First of all, can you explain what is Glide Path Stability and how does your team … score Glide Path Stability for various target-date funds?
Stempien: So this really spawned out of some research we did a couple of years back on what we call Glide Path Stability or Glide Path Instability. So it started with the paper that we wrote where we really measured, how much are glide paths actually changing? And when I say glide path I mean just the equity glide path--so ignoring the sub-asset classes and the implementation funds being used within the glide path, but simply looking at how aggressive that glide path is.
We were curious to see, are those glide paths changing over time? When a plan chooses a glide path provider, are they really getting what they signed up for, or two years later has that changed significantly?
So we look at the average absolute change in the level of equity across a glide path over time, and we use that to come up with a quantitative scoring system. Those that scored a low number indicates that there is little change among the glide path, and those fund families with a higher number indicate more fluctuation throughout the glide path.
Zoll: So if I'm an investor who is using a target-date fund, and then find that the fund company has suddenly changed its glide path, should that be a red flag for me? Is that something I should be concerned about?
Stempien: Well, that's a great question, and when we think about things, sometimes it is important to remember that the bulk of target-date assets are in qualified plans--so defined contribution 401(k)s really hold the bulk of the assets.
So as a plan participant, they generally don't have the ability to say, hey, I don't like this target-date fund; I'm going to move to another fund family's target-date series. So really to us we think that onus is on the plan sponsor to be really doing their due diligence in monitoring their target-date series, and the hope for the average employee out there is that their company is doing that due diligence to monitor that.
We are not saying that glide path shifting is, in and of itself, good or bad. But that company or that plan sponsor should really know and understand why it's changing, and if they don't know why it's changing, or they don't think it should be changing, well, then hopefully that's a red flag for that company to look at asking those questions and potentially looking to switch to another provider if that's a concern for them.
Zoll: So what are some reasons why a fund company would alter a glide path? Is it because maybe equities had underperformed, so they're trying to make up for that? Or what are some of those issues that would have an influence there?
Stempien: I think there are a number of reasons that glide paths change. The most common one that we see is some target-date providers implement a tactical overlay, so they are going to forecast what they think certain asset classes or markets are going to do, and if they think that the outlook for equities is very poor, they may choose to shift that glide path to be more conservative, or vice versa in other market environments.
So if that target-date provider is upfront about saying we're going to be tactical and shift this, and they can outperform doing that, that may be fine as long as the plan knows that.
There are a number of other reasons--you mentioned performance. Performance could be a reason. … For those target-date series that come up with strategic asset allocation or equity levels, the hope is that they really stick with that, because that's what plan sponsors are choosing as most appropriate for their plan. So if a plan is changing that, and it's unbeknownst to the plan sponsor and its employees, that can become problematic.
So what we're striving for is to make sure that when these glide paths are changing, are they justified changes and are they announced or made publicly available to the clients or the investors within a target-date series.
Zoll: Those are good questions to ask. Jeremy, thanks for sharing your insights on target-date funds with us today.
Stempien: No problem. Thanks for having me.
Zoll: For Morningstar, I'm Adam Zoll. Thanks for watching.
Transparency is how we protect the integrity of our work and keep empowering investors to achieve their goals and dreams. And we have unwavering standards for how we keep that integrity intact, from our research and data to our policies on content and your personal data.
We’d like to share more about how we work and what drives our day-to-day business.
We sell different types of products and services to both investment professionals
and individual investors. These products and services are usually sold through
license agreements or subscriptions. Our investment management business generates
asset-based fees, which are calculated as a percentage of assets under management.
We also sell both admissions and sponsorship packages for our investment conferences
and advertising on our websites and newsletters.
How we use your information depends on the product and service that you use and your relationship with us. We may use it to:
To learn more about how we handle and protect your data, visit our privacy center.
Maintaining independence and editorial freedom is essential to our mission of empowering investor success. We provide a platform for our authors to report on investments fairly, accurately, and from the investor’s point of view. We also respect individual opinions––they represent the unvarnished thinking of our people and exacting analysis of our research processes. Our authors can publish views that we may or may not agree with, but they show their work, distinguish facts from opinions, and make sure their analysis is clear and in no way misleading or deceptive.
To further protect the integrity of our editorial content, we keep a strict separation between our sales teams and authors to remove any pressure or influence on our analyses and research.
Read our editorial policy to learn more about our process.