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The $1 Trillion Target-Date Fund Landscape

Sizing up the increasingly passive giant in 5 charts.

Target-date funds hit a momentous mark in 2017 by eclipsing $1 trillion in assets.The funds' unimpeded growth means target-date funds play an increasingly important role in retirement success for more and more investors. Morningstar's

covers recent developments in the competitive landscape. Here's a summary of target-date fund landscape in just five charts.

Assets in target-date mutual funds totaled roughly $1.11 trillion at the end of 2017, up from $880 billion at year-end 2016. The asset growth is remarkable: Industry assets amounted to only $158 billion at the end of 2008. (Exhibit 1 shows the year-over-year asset growth of target-date mutual funds.)

Target-date funds also saw an all-time high in estimated net flows in 2017. The estimated $70 billion of net flows that went to target-date mutual funds in 2017 edged the previous high of $69 billion set in 2015 and represented a notable increase from $59 billion in 2016. The net flows have been consistently strong, exceeding more than $40 billion each year since 2008.

Quite possibly the most remarkable trend for target-date funds in 2017 was investors' dramatically increasing preference for series that own passively managed funds. Nearly 95% of the $70 billion estimated net flows to target-date funds in 2017 went to target-date series that invest predominantly--at least 80% of assets--in index funds. (While these are commonly referred to as passive target-date series, no series is truly passively managed, as every target-date manager makes active decisions in building a glide path and selecting asset classes, sometimes tactically based on market outlooks.) As seen in Exhibit 2, this trend started in 2015 when passive target-date series' net flows exceeded those for active ones.

Firms that manage target-date funds increasingly have launched additional target-date series in an attempt to meet investors' preferences. Firms initially came to market with just a single approach to target-date investing, but several firms have also launched a second or even third target-date series. As shown in Exhibit 3, while 60 series of target-date mutual funds existed at year-end 2017, those came from just 41 firms.

A firm's least-expensive series generally has been the most popular. Firms with multiple target-date series often offer a version that invests predominantly in index funds as an alternative to one that holds actively managed underlying funds. These versions typically follow the same general asset-allocation approach as the legacy series but for a lower fee, and they subsequently attract more flows than the older sibling series. An exhibit in the full report shows that BlackRock, Fidelity, John Hancock, Schwab, TIAA-CREF, and Voya each saw the highest estimated net flows in their passive series in 2017. In the cases of BlackRock, John Hancock, and Voya, which each offer three series, one of their passive series was the only one with positive estimated net flows in 2017.

The multiyear downward trend in fees continued for target-date funds in 2017. Exhibit 4 shows that the average asset-weighted expense ratio for target-date funds fell to 0.66% at the end of 2017, a 5-basis-point decline from 0.71% the previous year. The average asset-weighted expense ratio has come down by more than 35% since hitting 1.03% at the end of 2009.

The declining asset-weighted expense ratio comes from a variety of sources: existing target-date providers lowering their fees, investors selecting lower-cost share classes, the liquidation of pricey target-date series, and the arrival of competitively priced series. A review of how each series' asset-weighted expense ratio changed over the past year helps identify the source of the decline. An exhibit in the full report shows each series' year-over-year change in asset-weighted expense ratio.

A comparison of sub-asset-class exposures of active and passive target-date series reveals notable differences between the two. Exhibit 5 shows that passive target-date series, on average, placed more assets in core/other bond than their active peers, particularly near or into the retirement phase. This relative overweighting came at the expense of high-yield bonds, foreign bonds, and Treasury Inflation-Protected Securities. The limited availability of index funds in those asset classes may deter passive target-date series from gaining exposure.

Active target-date series had a higher cash stake than passive ones across the glide path. While underlying index funds can be expected to stay fully invested, active funds commonly maintain a small cash position for transactions.

The portfolios of passive target-date series are far from identical to each other. From a sub-asset-class viewpoint, passive target-date series tended to be more different from one another than active ones.

In addition to covering recent developments in the competitive landscape, this year's report highlights noteworthy considerations for target-date investors in five areas: Price, Performance, Parent, People, and Process.

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