<!-- Swiftype Variables -->

Special report: target-date funds

Cost-cutting takes precedence in competitive environment

Managers continue to find ways to reduce fees for DC participants

Douglas Balsam sees passive target-date proliferation as a cost-cutting incentive.

U.S. target-date fund managers are continuing to find ways to cut costs amid heightened fee scrutiny from plan executives and consultants, increased competition among managers, and a desire among managers to help improve participants' retirement income.

In February, Putnam Investments unveiled a lower-cost share class for its Retirement Advantage Funds, a series of 10 actively managed target-date funds structured as collective investment trusts. The new share class has a management fee of 0.35%, compared with the 0.5% previously charged, a Putnam spokesman said.

Other target-date fund managers that have announced price cuts of 2 basis points or more over the past year include American Century Investments, Fidelity Investments, J.P. Morgan Asset Management (JPM), Manning & Napier Inc. and GuideStone.

Consultants and researchers were quick to point out that target-date fund fees have been declining for some time. The average asset-weighted expense ratio for a target-date mutual fund series was 0.71% as of Dec. 31, 2016, down from 1.03% at the end of 2009, according to the most recent data available from Morningstar Inc.

In a news release on Putnam's new share class, Steven P. McKay, head of defined contribution investment only, said the Boston-based firm was "laser-focused on addressing the issues most important to plan sponsors and consultants, including fees, transparency and performance."

David O'Meara, New York-based senior investment consultant at Willis Towers Watson PLC, attributed part of the focus on fees to plan executives' growing appreciation of their fiduciary duty to help participants achieve the "retirement outcomes that they desire and deserve."

Concerns over litigation also have driven plan executives to be increasingly cost conscious, consultants and researchers said. In 2017, more than 30 lawsuits were filed alleging excessive fees in retirement plans, said data on Groom Law Group's website. By comparison, only about 80 excessive-fee lawsuits were filed in the decade prior, the law firm said. The lawsuits addressed not just target-date funds but also other investment options.

Some of the reasons plan executives might be particularly sensitive to target-fund fees, sources said, is their popularity as a qualified default investment option and the heightened visibility that comes with that, along with the ease of comparing expense ratios over target-date features like glidepath design and performance.

Just one approach

Putnam's launch of a lower-cost share class is just one approach target-date managers have taken to reduce fees.

For certain active target-date series, American Century and Fidelity switched in 2017 to a direct management fee model that charges a flat fee, from the traditional indirect fee model where target-date funds' net expense ratios are determined by underlying fund fees.

Plan executives stand to benefit from the direct management model when managers make underlying fund changes, said Joe Haas, Kansas City, Mo.-based product manager, multiasset strategies, at American Century.

Five months after the direct management fee model was put in place for American Century's One Choice Target-Date Portfolios, the firm was able to add an emerging market corporate debt strategy at no additional cost to plan participants, Mr. Haas said. Under the old fee model, changing an underlying strategy would have had a "tangible effect on the expense ratio," he added.

When the new fee model was put in place, expense ratios for most mutual fund share classes for the One Choice portfolios were reduced by 6 basis points, while the expense ratio for the R6 share class (which doesn't have revenue sharing) fell by 13 basis points, he said.

Mr. Haas said the new fee structure reinforced the firm's "commitment to being competitively priced in the target-date space" and providing better retirement outcomes for participants.

When the new pricing structure was put in place at Fidelity in June, total expenses for the Fidelity Freedom Funds and Fidelity Advisor Freedom Funds series were reduced by at least 2 basis points per vintage year, said Fidelity spokesman Adam Banker in an email.

Mr. Banker declined to comment on whether the Fidelity's decision to implement a new fee structure was related to outflows the firm has seen from its target-date mutual fund series.

In 2016, MFS Investment Management lowered expenses for its Lifetime target-date series by adding several lower-cost underlying equity funds. The new underlying funds use the firm's blended research strategy, which combines fundamental and quantitative analysis. When a portion of each fund's exposure was reallocated to the blended funds from existing fundamental equity funds, fees were reduced by 3 basis points to 8 basis points by vintage year, MFS spokesman Daniel Flaherty said in an email. At the same time that MFS added the blended research funds, it added class R6 shares to the target-date series. Fees for the R6 share class range from 0.44% to 0.52% depending on the vintage year, Mr. Flaherty said.

Active vs. passive

Other ways target-date fund managers have driven down costs has been launching purely index-based series or strategies that blend active and passive strategies.

In 2016, Charles Schwab Investment Management Inc. introduced a series of index-based target-date mutual funds made up of low-cost Schwab exchange-traded funds. With an all-in expense ratio of 8 basis points, the Schwab Target Index Funds are the lowest cost target-date mutual fund series in the market, said Jeff Holt, Chicago-based director of manager research for multiasset and alternative strategies, at Morningstar.

The previous year, Pacific Investment Management Co. LLC introduced the RealPath Blend target-date series. PIMCO actively manages the fixed-income piece; Vanguard Group Inc. passively manages the equity piece.

The net expense ratios range from 0.19% to 0.35% depending on the vintage year, according to fee data provided by PIMCO spokeswoman Agnes Crane.

Other managers that launched blended active/passive strategies include J.P. Morgan Asset Management (JPM), Principal Financial Group and AllianceBernstein (AB) LP (AB).

According to a Mercer survey of 68 off-the-shelf target-date mutual fund and CIT series with $1.7 trillion in combined assets, passive strategies are the most popular target-date choice, capturing 51.8% of target-date assets as of Dec. 31, followed by active strategies at 36.8%, and passive/active strategies at 11.4%.

Also as of Dec. 31, median fees across vintage years for actively managed target-date funds ranged from approximately 0.46% to 0.6% vs. approximately 0.1% to 0.13% for passively managed target-date funds, according to Mercer.

Douglas Balsam, Chicago-based principal and director of institutional consulting at DiMeo Schneider & Associates LLC pointed to the popularity of low-cost passive target-date strategies as another reason target-date managers have looked to cut costs.

James Veneruso, Summit, N.J.-based senior vice president at Callan LLC, observed passive target-date managers have continued to cut fees alongside active managers, The "pressure has really been on everyone." Mr. Veneruso said. "In order to get traction, your fees have to be competitive."

Preet Prashar, Chicago-based senior research analyst at Pavilion Advisory Group Inc., agreed: "If one target-date manager lowers fees, then there is certainly some pressure on other managers to lower fees if their funds are priced higher."

Mr. O'Meara of Willis Towers Watson added that increasing flows to target-date funds in general have helped target-date managers build scale, and they are using that scale to bring down fees.

While most sources said they believed managers would continue to find ways to lower target-date fees, they said they could see a target-date fund fee increase if there were a greater willingness by managers to diversify into areas like real estate, infrastructure, hedge funds or private equity.

Fees not only factor

Consultants and researchers emphasized that while fees are a necessary consideration, there are other factors to consider when evaluating target-date managers.

"When it comes to target-date funds, fees should not be the first thing investors look at," said Morningstar's Mr. Holt. Rather, investors should consider what is attached to the price tag, such as glidepath design and how comfortable they are with the portfolio team, Mr. Holt said.

Michael Volo, senior partner at investment consulting firm Cammack Retirement Group Inc. in Wellesley, Mass., said one of the first things his firm's clients consider when evaluating target-date managers is how comfortable they are with the risk profile.

"We don't have to motivate anyone to think about fees," said Neil Lloyd, Vancouver, British Columbia-based head of U.S. defined contribution and financial wellness research, at Mercer. The awareness is "always there," One of the areas Mercer does urge its clients to think about, however, is a target-date manager's allocations to U.S. equity vs. international equity. A 45% international equity/55% U.S. equity portfolio allocation is more consistent with the MSCI All Country World index, but a lot of target-date managers are much more biased toward U.S. equity, Mr. Lloyd said.