Is Open Architecture the Answer for Target-Date Managers?

Despite the challenging barriers to entering a concentrated market, a new study points to open-architecture series as a way for target-date fund managers to benefit from increased demand for their products.

While TDFs’ asset growth has been significant over the past decade, participation in this growth has been dominated by only a few providers, according to the October 2017 issue of The Cerulli Edge—U.S. Monthly Product Trends Edition.

Currently, across mutual fund and collective investment trust (CIT) target-date products, the top three managers retain 62.6% of the market and the top 10 account for 88.9%, making it extremely challenging to successfully launch new products in the sector, Cerulli notes. Moreover, asset managers without well-rounded asset allocation capabilities find themselves unable to develop and distribute their own target-date series.

The report suggests that one way for managers without their own funds to participate is through managing a sleeve of an open-architecture fund. According to Cerulli’s survey of target-date managers, 50% offer open-architecture products – 27% offer only open-architecture funds and 23% offer both open- and closed-architecture target-date products – with the overall percentage up from 46% in 2016.

Cerulli notes that the most common drivers behind a manager choosing open architecture include the belief that participants benefit from asset manager diversification and the need to outsource allocations where they do not offer best-in-class strategies. Those factors were cited by 77% and 69% of asset managers, respectively, who indicated they have an open-architecture target-date product.

“This bodes well for boutique managers that offer best-in-class strategies, especially those that are more esoteric in nature,” Cerulli says, adding that, “A vital requirement for these firms will be articulating how they can bring a differentiated investment process to the relationship.”

While open architecture presents opportunities, the report further explains that there are limitations. Those stem from target-date managers already having in-house expertise and the fact that incorporation of unaffiliated managers would increase the overall expense ratio of the fund. Moreover, Cerulli notes that “[d]ue to recent litigation, plan sponsors have been hyper-vigilant of cost, leaving little incentive for managers to focus on manager diversification, or truly finding best-in-class capabilities.”

Meanwhile, Cerulli’s report maintains that choice of a TDF glidepath is arguably the most important decision for plan sponsors relative to the long-term outcomes of plan participants. The firm asserts that, by gaining an understanding of employee demographics and plan sponsor perspectives on retirement savings and investing, a target-date manager is better positioned to convey how their product’s glidepath aligns with the plan’s objectives.

The report further shows that mutual fund assets ended the third quarter of 2017 with more than $14.1 trillion. In addition, year-to-date flows total $204.4 billion, of which $42.7 billion came during the third quarter. Net flows continue to move into ETFs at a “torrid pace,” according to the report, with the vehicle garnering nearly $87 billion during the third quarter of 2017, bringing the year-to-date figure to $330.6 billion. Moreover, the report notes that asset growth has accompanied flows, as ETF assets increased 6.5% during the third quarter, finishing above $3.1 trillion.

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