TDF Market Center of DC Industry Growth and Innovation

Combining an active investment approach with passive within the TDF can generate alpha when possible while also addressing cost concerns.

By Javier Simon | December 21, 2016
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Retirement plan advisers know the story well: Released decades ago as investment vehicles for retirement plan participants who want to step back from managing their investments, target-date funds (TDFs) have, since the passage of the Pension Protection Act (PPA) of 2006, won a sizable chunk of the defined contribution (DC) market.

According to the Investment Company Institute (ICI), mutual fund-based TDF assets reached a record high of $790 billion in the first quarter of 2016, with almost 68% of that credited to usage of TDFs in DC plans. These funds are the most popular qualified default investment alternative (QDIA), used by  72% of large- to mega-sized 401(k) plans, according to a recent study by asset-management and research firm AB. And there is an impressive and increasing diversity of TDF products, as Morningstar now tracks more than 51 different TDF series.

With so much ongoing development in the market, new products are emerging with designs that vary widely in terms of asset allocation; underlying fund selection process, which can be firm-specific or open-architecture; investment strategy, which can be active, passive or a mix of both; and glide path, which can either travel “to” or “through” a participant’s retirement.

“All these need to be considered against the plan’s overall objective and philosophy,” suggests Toni Brown, senior defined contribution specialist, Capital Group. She also notes TDF prospectuses, historical performance, and risk statistics are all crucial to review.

Like others, Brown suggests these factors need to be scrutinized even more in a rapidly changing regulatory environment with heightened retirement risks.

“As people are living longer, we need to do more to hedge against retirement capital being eroded by things like inflation,” agrees Tony Fiore, senior vice president and national sales manager of retirement investment solutions at Prudential Investments.

AB also notes that the industry is seeing innovations to meet these goals. The firm suggests some key areas where plan sponsors can evolve TDF design. First, it recommends considering a multi-managed or open-architecture approach to asset management with a diversified mix of underlining funds that utilizes well-tested stocks, bonds and non-traditional asset classes. It also points to adopting a dynamic rather than static approach that responds to short-term market fluctuations but also mixes passive strategies to enhance risk-adjusted returns and manage costs.

AB also recommends using a glide path that looks to enhance results in the distribution phase of a retirement plan, which it calls a “critical but often overlooked component of any retirement plan solution.”

NEXT: Other opinions on TDF design