Increased fee sensitivity is compelling target-date asset managers and retirement plan consultants to explore new options for product development, according to a new report by Cerulli Associates.
In its third quarter 2019 issue of The Cerulli Edge—U.S. Retirement Edition, the firm explains that fee compression in target-date funds persists unabated as asset growth continues at a rapid clip but remains concentrated in a handful of asset managers that dominate the space. What’s more, the scale of assets required to launch a new TDF priced low enough to compete with the largest managers is an increasingly powerful barrier to new entrants.
Facing those undercurrents, Cerulli notes that TD managers and plan consultants are exploring new avenues for customization, such as blending active and passive strategies, creating white-labeled, open-architecture products and incorporating a transition to managed accounts.
Active/Passive Shift
In 2018, assets in passive TD mutual funds grew by 5.4%, while those in active TD mutual funds contracted by 7%. And although total active TDF assets remained higher than passive, their market-share lead over passive TDFs fell to 12% in 2018 from 18.1% in 2017, the firm notes.
New product development, such as hybrid TDFs, which use a combination of active and passive management, apparently is changing this dynamic. “Assets invested in hybrid target-date funds are growing, and nearly half of target-date managers surveyed believe that hybrid target-date products will gather meaningful defined contribution plan assets during the next one to three years,” says Daniel Uquillas, a senior analyst at Cerulli.
To the surprise of one senior executive interviewed by Cerulli, interest in and adoption of hybrid TDFs are coming from both plan sponsors with fully active offerings and those with fully passive offerings. Contrary to the intuitive expectation that most interest in hybrid products would come from fully active sponsors looking to pay lower fees, equal interest has come from fully passive sponsors, which may view the active component as a means of providing downside protection in the event of a market downturn, the report explains.
CITs and Customization
Cerulli further observes that while the majority (61%) of TD assets remain in mutual funds, CITs are steadily gaining market share and reached 39% of the total TDF market in 2018, up from 32% in 2015. The firm believes this trend will continue as plan sponsors look for lower-cost products and increased flexibility. In addition, CIT providers’ move down-market will likely boost market-share growth, as providers have slowly allowed investment minimums to come down, allowing for smaller plan sponsors to allocate to the product.
Meanwhile, as TDF managers continue to look for ways to deliver customized solutions at scale, some plan consultants are trying to distinguish themselves by creating open-architecture, multimanager TDFs with different subadvisors for each asset class, Uquillas further explains. These white-labeled products he notes are typically implemented in a CIT structure, allowing for lower costs and less operational complexity. Another executive interviewed by Cerulli estimates that nearly three-quarters of mid-market 401(k) plan aggregators are interested in collective, custom TDFs and that interest has increased in the past 18 months.
While Cerulli expects this trend to accelerate, the firm’s data shows that the majority (58%) of surveyed firms do not offer any open-architecture TD products and that the largest TDF providers consistently offer only closed-architecture solutions.
Managed accounts are also on target-date managers’ radars. More than one-third (35%) of survey respondents believe that managed account implementation as a QDIA for DC plans will increase during the next one to three years.
What’s more, the firm found that nearly half (43%) of respondents agree that TDFs are not customized enough for participants in or near retirement, because as participants age or achieve greater account balances, their risk tolerance skews toward asset preservation, often requiring more customization than what a TDF can provide.
When asked about the likelihood that various attributes will be included in the development of new TD products, TD managers most frequently cite the incorporation of a transition to managed accounts, also referred to as dynamic solutions. “We recommend that target-date managers examine the potential demand for dynamic solutions, as many savers nearing retirement could benefit from customization,” Uquillas emphasizes.
