Beyond TDFs

Target-date funds are the undeniable leaders in the retirement saving industry. As the default investment vehicle for most employees with defined contribution plans, TDFs have surged in popularity over the years.

“Target-date funds have been very effective as a way to get millions of participants a professionally-managed portfolio that’s based upon their age,” says David Blanchett, head of retirement research for PGIM DC Solutions.

But looking forward, the optimal portfolio probably isn’t the exact same for everyone that’s within a five-year age cohort.

“We’re going to continue to see other professionally-managed solutions emerge as possibilities,” Blanchett says.

Solutions will range from investment options with a long track record, such as stable value funds, to newer solutions, such as adviser managed accounts. Which solutions gain the most market share, however, will depend on the demand and use they get from plan advisers and sponsors.

Risk-Based or Balanced Funds

Just 27% of defined contribution plans offer risk-based or balanced funds, which compares to 97% that offer TDFs, according to NEPC’s 2023 DC survey on plan trends and fees. The percentage of balanced funds continues to go down over time, and most of those that offer risk-based funds are doing so in addition to offering TDFs, says Mikaylee O’Connor, principal and head of defined contribution solutions at investment consulting firm NEPC. In other words, risk-based funds are not necessarily a worthy rival to TDFs.

The main reason balanced funds are losing ground is that when you look at the investment menu design, the trend has been to streamline, providing less choice but broader investment options to participants, O’Connor says. TDFs have more benefits than balanced funds because they include the de-risking component over time.

“A lot of committees are saying, ‘Well, these are somewhat redundant,’” O’Connor says. “They’re essentially removing the balanced fund and mapping those assets to the TDF.”

However, one area in which she says risk-based funds could see a reemergence is in the retirement income space. While today’s TDFs have a single income vintage, there may be a market for multiple income vintages that span the risk-return spectrum to offer more tailored options for retirees, O’Connor says.

Managed Accounts

Managed accounts personalize allocations for participants more than TDFs can—and they are where the industry looks poised to eventually evolve to, Blanchett says.

“Managed accounts consist of further adding on additional layers of portfolios that can be calibrated to not only the plan information but also each participant,” he adds. “It’s taking into account what we know about that person and then further personalizing the portfolio based on their situation.”

NEPC’s data shows that 43% of defined contribution plans offer managed accounts. But these accounts’ biggest hurdle is the current fee model.

“What we would like to see and what we have been talking to the market about is a managed account solution that’s implemented at a lower fee for less engaged participants,” O’Connor says.

For instance, providers could offer an entry-level option that could be structured as the default, replacing the TDF, then more engaged participants could access additional services and potentially expanded investment options through a tiered subscription offering.

“This approach could cater to flexibility in costs and features while still catering to a diverse participant need and differing engagement levels,” O’Connor adds. While this type of offering isn’t available now, she says if it was available, it could give managed accounts the potential to gain more ground on TDFs.

Stable Value Funds

Stable value funds have been around since the inception of defined contribution plans, and they haven’t changed much in recent years. They’re designed to provide steady returns regardless of the market environment and have accumulated $856 billion in assets under management as of mid-year 2024, according to data from the Stable Value Investment Association (SVIA), making up roughly 10% of all retirement assets.

While there used to be a competition between stable value funds and TDFs for qualified default investment alternative status, nowadays they’re seen more as partners, says Zach Gieske, president of SVIA. Participants may invest in TDFs when they’re younger, and then transition into stable value funds once they hit age 50. And stable value is often used within custom target-date structures to provide a better risk-return profile, he adds.

 “Even in the decumulation phase, there is space for both to work well together,” Gieske says.

Adviser-Managed Accounts

With adviser-managed accounts, an individual adviser uses a recordkeeper’s technology and infrastructure, but controls the investment part of the account, such as the pricing and branding. O’Connor says this type of solution is gaining traction as a replacement to TDFs in the pooled employer plan space for small plans.

“It’s a way for the advisor to essentially make more money,” she explains.

The default is a managed account, and the adviser can have a say in terms of the investing approach.

“It’s hard to wrap an adviser fee on a TDF,” O’Connor says. “They can wrap a fee on the whole plan, but an adviser can provide additional services to these participants within the smaller plans.”

She added that they haven’t seen this trend pick up among larger plans.

While plan sponsors seem overwhelmingly happy with TDFs, there may be transition in the years to come.

“We’re at an inflection point with the ability to leverage technology and use it within the DC system,” says O’Connor. “There’s so much potential out there, it’s just [about] how fast the DC space will actually move.”