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Look Beyond a Target-Date Fund’s Expense Ratio

Morningstar’s latest report includes 5 considerations in addition to a fund’s expense ratio

Jeff Holt, Morningstar Research Services LLC

 

Target-date funds are designed to be a simple, all-in-one solution and relatively easy for investors to use. Their simplifying features, however, can also make these funds tricky to evaluate. A look at the most popular target-date funds among investors could make it seem that the merit of a target-date fund series rests entirely on its fees. But fund-expense ratios don’t necessarily tell the whole story.

In our report “2019 Target-Date Fund Landscape: Simplifying the Complex,” we previewed some of the new data points and exhibits included in the enhanced Morningstar Target-Date Fund Series Reports, which provide investors with a comprehensive view of a target-date series.  

Here are five things from the report that investors can use to evaluate target-date fund series. 

  1. Pinpoint hidden differences in approaches. Comparing sub-asset-class glide paths may reveal significant differences in approaches—even between target-date series that invest only in index funds—that aren’t apparent by examining strategic equity glide paths. For instance, investors can use the report to see that the Vanguard Target Retirement series tilts much more to foreign bonds than the typical peer across the glide path. These types of differences thwart the notion that any target-date series can be truly passive; target-date managers make active decisions in determining the desired asset allocations. 
  2. Compare the quality of underlying holdings. Target-date providers commonly use underlying funds as the building blocks in their construction of target-date funds. The Morningstar Analyst Rating™ gives investors a forward-looking opinion of these funds’ prospects. Only 18 of the 63 target-date series we evaluated held most of their assets in Morningstar Medalists, and only five series had 90% or more in Morningstar Medalists.  
  3. Track manager-roster changes. It’s important to track changes to the manager roster, as these shifts may result in adjustments to a series’ investment approach over time. In 2018, nearly half of target-date fund series—30 of 63—gained or lost a manager.  
  4. Know which managers invest in their series. Few target-date fund managers invest heavily in their series, which may signal a lack of conviction in their strategy. The reports show that only 16 of roughly 140 target-date fund managers invested more than $1 million in their series as of year-end 2018. Of that 16, four of the six managers who run multiple series invest in a higher-cost legacy offering that relies predominantly on actively managed underlying holdings. This approach counters the overall direction of investor flows to lower-cost series.       
  5. Put fees in proper context. As expected, target-date fund expense ratios increase as the amount they hold in active funds does. The number of target-date series that don’t invest predominantly in either active or passive strategies, but fall somewhere in the middle, has increased in recent years. This trend amplifies the need to consider a series’ percentage in active funds when determining the competitiveness of the funds’ expense ratios.   

By examining these aspects, in addition to considering the price tag, investors can gain greater confidence in their target-date fund. 

All target-date series reports are available inMorningstar Direct’s Research Portal. If you’re a user, you have access. If not, take afree trial

To learn more about these considerations and the key trends in the competitive landscape, download our paper.

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The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. The opinions expressed are as of the date written and are subject to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information contained herein is the proprietary property of Morningstar and may not be reproduced, in whole or in part, or used in any manner, without the prior written consent of Morningstar. Investment research is produced and issued by subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC, registered with and governed by the U.S. Securities and Exchange Commission. 

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