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Intensifying Demand Seen for Low-Fee TDF Options

Industry Trends and Research

Amid rising demand for low-fee options, target date providers are responding by offering inexpensive options like collective investment trusts or launching new lower-cost series that rely on passive funds.

And even though assets in target-date mutual funds shrank in 2018 for the first time since 2008, the overall market grew, as providers gathered assets into collective investment trusts (CITs), according to Morningstar’s annual Target-Date Fund Landscape Report, which evaluates more than 60 series of TDFs.  

Assets in target-date strategies overall totaled more than $1.7 trillion at the end of 2018, with mutual funds receding slightly to $1.09 trillion from $1.11 trillion at year-end 2017. Assets in target-date CITs totaled approximately $660 billion, which was nearly a $30 billion increase in a year when returns were negative. Even still, target date mutual funds remain a popular option for investors, receiving an estimated $55 billion in net inflows for the year, according to Morningstar. 

Low-Fee Demand

As noted, price apparently drove demand. Nearly all the $55 billion estimated net flows to target-date mutual funds in 2018 went to low-cost series that held more than 80% of assets in index funds. Moreover, assets moved to lower-cost share classes, bringing the average asset-weighted expense ratio down to 0.62% from 0.66% in 2017.  

By contrast, series that held less than 60% of assets in index funds saw little demand in 2018. Target-date series that held mostly actively managed funds still had more assets than series that invest predominantly in index funds at year-end 2018, but the latter is “catching up quickly,” Morningstar notes.  

Overall, those series with more than 80% of assets in actively managed underlying funds held approximately $570 billion in assets at year-end 2018, while ones with less than 20% in actively managed underlying funds had nearly $480 billion. 

“If recent trends hold, series that invest predominantly in index funds could overtake series that hold mainly active funds within a couple of years,” the report suggests.  

But in emphasizing that “passive target-date funds” do not really exist, Morningstar points out that its analysis of sub-asset-class glide paths identified significant differences in approaches – even between series that invest only in index funds – that are not apparent by examining strategic equity glide paths.  

To that end, the firm notes that it will be rolling out enhanced TDF series reports featuring new data points and exhibits to simplify the complexities investors face when evaluating TDFs. 

Fund Launches

While multiple providers have launched less-expensive alternatives to their legacy offerings or made their strategy available in lower-cost vehicles like CITs, 2018 apparently was quiet for fund launches, continuing a trend of no more than five new series launch in any calendar year since 2009, the report explains. 

Only two new target-date series joined the fray in 2018 – the fewest since 2013 – and both came from providers that already offered a target-date series.

What’s more, the report notes that the returns of a target-date provider’s newer, lower-cost series did not always outpace those of the legacy. Of the 10 target-date series that replicate a legacy offering but with lower fees, the since-inception returns for three failed to keep pace.  

Meanwhile, continuing an ongoing trend, a small number of providers continue to dominate the target-date fund market, while numerous other firms “compete for scraps.” According to the report, seven providers had 90% of the target-date assets at year-end 2018, leaving more than 30 other firms to compete for the remaining 10% of market share. Vanguard holds nearly 40% of the TDF market at year-end 2018 with nearly $650 billion in total assets across its mutual fund and CIT series.