Target-date funds have been a difficult sell in the U.K., but some in the retirement industry believe the strategies soon will gain traction in the defined contribution market as multiple employer trusts become increasingly popular.
Target-date strategies have taken off in the U.S. and are continuing to grow. The latest analysis by Pensions & Investments of the 1,000 largest U.S. retirement plans showed 18.4% of the $3.28 trillion in total DC assets was invested in target-date funds for the year ended Sept. 30, up from 16.8% in the previous year. And Morningstar Inc. said U.S. target-date mutual fund assets grew 8.1% to $763 billion over 2015, and have increased 557.8% over the past 10 years.
In the U.K., however, the strategy has not captured assets in any comparable way. A report by data analytics and market intelligence consulting firm Spence Johnson Ltd. on the U.K. defined contribution market, published in 2016, put the institutional DC market at £107 billion, with target-date funds in default strategies around £3.1 billion.
But all that is expected to change as multiple employer plans, known as master trusts, look set to flourish in the U.K. DC market.
“We have really aggressively increased our forecast of target date over the next 10 years or so,” said Jonathan Libre, senior analyst in London at Spence Johnson. The expectation is that by 2025, about 27% of total default strategy assets will be in some sort of target-date structure. That forecast is up from last year, when Spence Johnson executives put target-date asset share at 20% by 2025. “Most of this will be driven by the master trusts,” said Mr. Libre, noting a number of plans, including the £1.3 billion ($1.6 billion) National Employment Savings Trust, London, have already adopted the structures.
Very important part
Spence Johnson executives expect master trusts to “be a very important part of the market in 10 years,” he said. U.K. master trusts account for about £6 billion of a £300 billion total DC market. In 2025, the firm expects master trusts to account for about one-third of what is expected to be a £1 trillion DC market.
Providers are also watching the development of the U.K. DC market closely, and are aware of the disparity in target-date popularity. “The TDF industry blossomed in the U.S. following the Pension Protection Act in 2006,” said Paul Farrell, London-based U.K. head of institutional at J.P. Morgan Asset Management (JPM). “Most companies' default arrangement prior to (the) early 2000s was to hold corporate stock or cash, but the act provided certain default arrangements, including target-date funds, with safe harbor” as qualified default investment alternatives. The QDIA regulation allowed DC plan executives to choose default options without fear of being sued, he said.
“In the U.K., insurance companies have always had the monopoly when providing pensions to DC plans and individuals, and have used lifecycle structures to do this,” Mr. Farrell said. “A managed account would be the most akin to a lifecycle in the U.S. but they have not seen as broad adoption as TDFs, often due to costs.”
Mr. Farrell also cited the rise of the master trust — as well as the U.K. being in the late stages of a multiyear regulatory-led effort to automatically enroll qualified employees into a workplace retirement plan — as an opportunity for target-date funds. “Now that we are getting toward the tail-end of auto enrollment, we are finding that trustees are starting to look at investment more closely and to question the performance of their default arrangements. This is where we are really starting to see TDFs step into the foreground — there is a realization that generally, the performance of lifecycle defaults is not being published.” He said target-date funds create a more transparent framework.
Another issue is while target-date funds have a place in the U.K. DC market, there is “nothing really wrong” with the lifestyle structure, said Emma Douglas, head of DC at Legal & General Investment Management in London. The firm runs target-date funds and is “starting to get some interest” — a couple of clients will be investing early this year. “You could argue target date provides a bit more sophistication in terms of managing that journey to retirement, a bit more flexibility,” she added. LGIM is “in the happy position” of offering both lifestyle and target-date options, she added.
AllianceBernstein (AB) LP (AB) has seen target-date fund assets grow to £2 billion, with 25% of that coming in the past year. Most of that growth has come from master trust clients, said David Hutchins, a senior vice president in London and head of the firm's multiasset solutions business in Europe, the Middle East and Africa. But target-date structures have been less popular with corporate plans. “There has been probably a disappointing takeup among corporate pension schemes, where there is a high level of intermediation — TDFs do not always work naturally with many consultants' current business model,” he said.
Nico Aspinall, an independent consultant who works with money managers and providers of DC plans, said some master trusts already are using target-date structures and others are considering them. “But mostly that is an administration decision; most are still in control of the assets themselves and very few have delegated to the TDF manager,” he said. “It is an admin convenience.”
Another angle that might help with the uptake of target-date structures in the U.K. is the increase of open-architecture approaches, blending multiple managers' strategies in the default option. It is a similar setup for money managers to lifestyle investment strategies, where they do not control all of the assets, nor the asset allocation.
This is a departure from the way the U.S. target-date fund industry has grown up and flourished. Sources said the closed-architecture option more common in the U.S. — where the underlying investments are provided by one manager — has not really taken off in the U.K. outside of a consultant's own business. “Whether third-party managers offering (closed-architecture) TDF options takes off in time and becomes a realistic business plan, we will see,” added Mr. Aspinall. “But probably the few launched already represent the peak of this type of approach.”
This article originally appeared in the March 6, 2017 print issue as, "Prospects brightening for target-date funds as U.K. market evolves".