Growth in TDF Market Underscores Proprietary Product Debate

The October 2017 issue of The Cerulli Edge – U.S. Monthly Product Trends Edition discusses the use of open-architecture investing strategies as a way for target-date fund (TDF) managers to benefit from increased demand and a greater desire for transparency.

As the report lays out, the main forces behind a given target-date manager choosing open architecture most commonly 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, according to 77% and 69% of managers, respectively.

On the other hand, for managers steering away from open-architecture approaches, the main reason is “having in-house expertise already,” and also the fact that incorporation of unaffiliated managers “would increase the overall expense ratio of the fund.”

Finding merit in both sides, Cerulli contends the choice of a target-date fund glide path is “arguably the most important decision for plan sponsors relative to the long-term outcomes of plan participants.” Cerulli further asserts that, by gaining an understanding of employee demographics and plan sponsor perspectives on retirement savings and investing, target-date managers are better positioning themselves to convey how their product’s glide path aligns with various plan objectives.

Other data shared by Cerulli shows, across mutual fund and collective investment trust (CIT) target-date products, the top-three managers own 62.6% of the market, while the top 10 account for 88.9%. Cerulli researchers argue this level of concentration “makes the space extremely challenging to successfully launching new product.” Furthermore, asset managers without well-rounded asset allocation capabilities “are generally unable to develop and distribute their own target-date series.”

Despite these challenging barriers to entry, Cerulli points to open-architecture series as a way for managers to benefit from increased demand for target-date products. As Cerulli explains, in open-architecture funds, target-date managers look to unaffiliated asset managers, often boutiques with best-in-class capabilities, to manage sleeves of the fund. According to Cerulli’s survey of target-date managers, “exactly half offer open-architecture products—27% offer only open-architecture funds and another 23% offer both open- and closed-architecture target-date products.”

The overall percentage of firms offering open-architecture TDF products is up from 46% in 2016, the reporting shows.

“Asset managers have been more inclined to pursue open-architecture arrangement funds for a number of reasons,” the report continues. Many viewed the 2013 DOL factsheet, Target-Date Retirement Funds – Tips for ERISA Plan Fiduciaries, as a likely motivator for asset managers to pursue open-architecture funds, as it encouraged plan sponsors to inquire about custom or non-proprietary target-date funds. However, only 23% of target-date managers find it was a very important reason for them to offer open architecture product. Again, the leading reasons for managers to cite for pursuing open-architecture are the belief that participants benefit from asset manager diversification and that managers need to outsource allocations where they do not offer best-in-class strategies.

Cerulli’s research concludes that the outlook for open-architecture is healthy, but not all positive: “While open architecture presents opportunity for managers that can navigate the lengthy, arduous sub-advisory due diligence process, there are limitations to this opportunity. For starters, only 12% of those offering closed-architecture products indicate they plan to consider open architecture, but do not expect a change over the next 12 months. The remaining 88% do not plan to move to open architecture.”

Additionally, many of the largest target-date series will likely remain closed architecture. Of closed-architecture managers surveyed by Cerulli, their most important reasons for not using unaffiliated managers are that they already have in-house expertise and that it would increase the cost of the overall expense ratio. “Due 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,” the research states.

Information on obtaining Cerulli Associates research reports is available here.