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Innovation in the retirement plan space is revolutionizing saving and investing, leading to better outcomes and better participant behavior. Target-date funds are no exception, making it easy(ier) for workers to stay the course through market shocks, in particular.
But are some fund companies—and their managers—taking advantage of investor apathy for their own benefit?
Yes, according to Michael Finke. The professor and Frank M. Engle Chair of Economic Security at the American College of Financial Services said more than 60% of employees that participate in retirement plans now use TDFs to save.
His research with PGIM’s David Blanchett found that “employees were less likely to contact their recordkeeper during the March 2020 COVID crash and far less likely to pull money out of stocks at the wrong time compared to self-directed investors.”
TDFs encourage employees to ignore their retirement investments, which he said is generally good because employees who manage their own investments tend to underperform.
However, some fund families appear to recognize that TDF investors rarely change their investments, and Finke credited further research presented at the 2024 American Finance Association meeting when explaining the problem.
“This creates an opportunity to manage a TDF in a way that isn’t best for participants because they aren’t monitoring manager behavior,” Finke said. “For example, the research authors, Massimo Massa, Rabih Moussawi and Andrei Simonov, found evidence that fund families used their TDF to buy shares of lower-performing funds within the same family. If a low-performing fund was seeing significant outflows, the TDF would step in and buy shares.”
FIND THE FULL RESEARCH PAPER FROM MASSA, MOUSSAWI, AND SIMONOV HERE
Also, the fact that a TDF is a fund-of-fund might lead people to underestimate the amount of total fees paid on both the TDF and the underlying fund.
“The authors found that TDFs tend to underperform other balanced funds, and the underperformance was worse after the PPA led so many TDFs to be used as default investments,” he added. “The most important takeaway is that when fund investors don’t pay attention, there are opportunities for some fund families to exploit inattentive investors.”
He pointed to a recent Blanchett LinkedIn post noting that the largest TDFs are among the most efficient and lowest-cost investments available to individual investors. He also said that the TDF market is increasingly concentrated among these lower-cost providers.
However, he concluded that “the most important takeaway is that consultants and plan sponsors need to be aware of the possibility for abuse among some TDFs and do their due diligence to ensure that the TDF they select is competitive.”
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