Puzzling use of passive target funds
Skip to main content
pilogo-NEW
Subscribe
  • Subscribe
  • My Account
  • login
  • NEWS
    • Asset owners and the coronavirus
    • Alternatives
    • Consultants
    • Coronavirus
    • Defined Contribution
    • ESG
    • Frontlines
    • Hedge Funds
    • Investing / Portfolio Strategies
    • Money Management
    • Pension Funds
    • People Moves
    • Private Equity
    • Real Estate
    • Searches & Hires News
    • SECURE Act
    • Special Reports
    • WorldPensionSummit
    • Ron Schmitz
      Pandemic drives faster transition for Virginia to private markets
      Mubadala Investment Co. logo
      Mubadala draws on portfolio in coronavirus fight
      T.J. Carlson
      Texas Muni reduces downside risk during pandemic, finding opportunities now
      Scott Davis
      ‘Triage plan’ at Indiana system helped stem losses
    • watch video
      0:45
      Private funds weathered 2020 turmoil
      Daniel McHugh
      Aviva Investors promotes from within for real assets CIO
      Marc Rowan
      More alts managers seek expansion to retail market
      Mellody Hobson, president of Ariel Investments, speaks during an interview in Hong Kong on Sept. 1, 2017
      Ariel launches effort to boost minority business owners
    • Kieran Mistry
      Hymans Robertson picks head for new non-traditional risk transfer unit
      Troy Saharic
      NEPC brings on director of new business development
      Bill Foley
      Foley-backed SPAC agrees to $7.3 billion deal with Alight
      Jason Schwarz, chief operating officer of Wilshire,
      New owners have big plans for future of Wilshire
    • Mitchells & Butlers turns off tap on pension contributions until April
      Jerome Powell, chairman of the Federal Reserve, adjusts his glasses during a Senate Banking, Housing and Urban Affairs Committee hearing in Washington on Sept 24, 2020.
      Powell says Fed will hold steady during economic recovery
      Institutional investors mobilize for equitable global COVID-19 response
      Few participants tapped savings to weather pandemic – Vanguard
    • DC plan sponsors differ on need for annuities – survey
      Biden’s retirement idea getting the cold shoulder
      Few participants tapped savings to weather pandemic – Vanguard
      pie chart with calculator
      Fidelity: Savers added big to retirement accounts in Q4
    • After strong 2020, ESG investments forecast to grow more – Moody's
      Emissions rise from the coal fired power plant in South Carolina
      U.K. managers seen pressuring firms on diversity, climate change
      Asset management industry remains vastly white, male – survey
      Institutional investors mobilize for equitable global COVID-19 response
    • Spirit winners
      Prudential honors young people who are helping out
      2 U.K. pension execs take on ESG investing in new podcast
      Donation illustration
      Jefferies will use trading commissions to do good
      Michael Arougheti
      SPACs ride wave as latest investment darling
    • Robert 'Rob' Shafir listens during a Senate Permanent Subcommittee on Investigations hearing in Washington on Feb. 26, 2014
      Sculptor hedge fund hits sixth straight year of outflows
      The WallStreetBets forum on the Reddit Inc. website on a laptop computer and the GameStop logo on a smartphone in an arranged photo.
      GameStop frenzy has hedge fund managers rethinking next moves
      Gabe Plotkin, chief investment officer and portfolio manager of Melvin Capital Management, speaks during the Sohn Investment Conference in New York on May 6, 2019
      Citadel, Point72 back Melvin with $2.75 billion after losses
      Shanghai skyline
      Global hedge funds struggle even in a more open China market
    • MassPRIM sets $450 million for 3 alts funds
      New Mexico allocates $105 million to 3 alts funds
      Boston Retirement tees up $45 million for 2 private market fund of funds
      Border to Coast picks 5 managers for infrastructure, makes first co-investment
    • Brightwood Capital adds senior investment professional
      Kimberley Stafford and Alec Kersman
      PIMCO names product strategy group head
      Praesidium chooses director of client service, business development
      York Capital appoints new managing director
    • New Hampshire taps New Mexico fund chief as new executive director
      IBM to input $300 million into international pension plans
      Arconic transfers $240 million in pension liabilities
      S. Korea’s National Pension Service gains almost 10% in 2020
    • Brightwood Capital adds senior investment professional
      New Hampshire taps New Mexico fund chief as new executive director
      Kimberley Stafford and Alec Kersman
      PIMCO names product strategy group head
      Praesidium chooses director of client service, business development
    • Carlyle secures $4.1 billion ESG-related credit facility
      Hamilton Lane raises $3.9 billion for fifth secondary fund
      PSG closes first Europe-focused fund at $1.5 billion
      Kohlberg closes latest private equity fund at $3.4 billion
    • Sebastiano Ferrante and Jocelyn de Verdelon
      PGIM Real Estate turns to staff to fill new roles
      European managers key in on specialist strategies
      Ingrid Jacobs
      Jones Lang LaSalle brings on head of diversity and inclusion
      EQT inks deal to buy real estate manager
    • Neal and Brady
      Retirement security could be only issue both sides accept
      Retirement cartoon
      Hopes rising for retirement readiness in 2021
      David Ireland
      Sponsors returning to questions about in-plan annuities
      Shawn O'Brien
      Annuities coming to target-date funds, but not right away
    • Charging Bull, sometimes referred to as the Wall Street Bull or the Bowling Green Bull, a bronze sculpture that stands on Broadway just north of Bowling Green in the Financial District of New York City
      Top-performing managers Q4 2020
      P&I 1,000 largest retirement plans: 2021
      Retirement in emerging markets
      Outlook 2021
    • U.S. still a key market for investors
      Collected coverage of P&I's 2020 WorldPensionSummit
      Pedestrians pass a large advertisement on the Arndale Center shopping mall reading 'Act now to avoid a local lockdown' in Manchester, England
      COVID-19 puts new opportunities and risks on the agenda - WPS panelists
      Screens display stock price information over the trading floor of the NYSE Euronext exchange in Paris
      Private assets will continue to grow in portfolios – WPS panelists
  • Data
    • Research Center
    • Searches & Hires Database
    • Searches & Hires News
    • RFPs
    • Charts / Infographics
    • Sponsored Research
    • Trackers
    • Q2 2020 searches and hires overview report
      Q2 2020 money manager M&A activity summary
      Q2 2020 legal overview report
      Q1 2020 searches and hires overview report
    • MassPRIM sets $450 million for 3 alts funds
      New Mexico allocates $105 million to 3 alts funds
      Boston Retirement tees up $45 million for 2 private market fund of funds
      Border to Coast picks 5 managers for infrastructure, makes first co-investment
    • MassPRIM sets $450 million for 3 alts funds
      New Mexico allocates $105 million to 3 alts funds
      Boston Retirement tees up $45 million for 2 private market fund of funds
      Border to Coast picks 5 managers for infrastructure, makes first co-investment
    • Emerging Market Equity Manager Services
      Securitized Credit Manager Search
      Private Placements Asset Manager Search
      Actuarial Consultant Search
    • Taiwan Semiconductor’s No. 1 in the emerging markets book
      U.S. fixed-income returns post another positive year
      Nasdaq delivers an impressive year
      U.S. dollar's recent decline continues
    • Institutional Investors: Shared Expectations, Divergent Paths
      Global Investor Study 2016
      Workplace Financial Wellness
    • U.S. Endowment Returns Tracker
      Pension Fund Returns Tracker
      Earnings Tracker
      Corporate Pension Contribution Tracker
  • Insights
    • Opinion
    • White Papers
    • Industry Voices
    • Letters to the Editor
    • Partner Content
    • Publisher's Update
    • Tesla cartoon
      Don’t confuse wealth creation with retirement saving
      Top 1000 cartoon
      Top 1,000 retirement plans weather storm just fine
      Infrastructure cartoon
      You must go big on infrastructure, Mr. President
      Retirement cartoon
      Hopes rising for retirement readiness in 2021
    • Shifting DC Times – Winter 2021
      Bond ETFs show maturity during Covid market mayhem
      Pension Consolidation: Optimizing Scale and Maximizing Efficiency
      China is embarking on a new stage of growth
    • Lawrence Cunningham
      Commentary: Gensler should keep Clayton’s pragmatic proxy adviser rules
      My-Linh Ngo
      Commentary: Pension funds and the role of the debt market in the fight against climate change
      Bill Peressini
      Commentary: Carbon’s elemental role in the future of impact investing
      Teresa Ghilarducci
      Commentary: Lower rates for longer mean a drastic rethink on funding
    • Writer using a typewriter
      OCIO industry needs to adopt GIPS
      Writer or journalist workplace. stock illustration
      Even as it assails China, Trump administration emulates it
      Skeptical of Main Street support for proxy adviser proposal
      Focus on manager diversity pushes asset owners’ to walk the talk
    • P&I Content Solutions
      How will gold react?
      To people shaking hands
      P&I Content Solutions
      Lessons From 2020: Today’s OCIO Model Passes a Major Test of Governance
      Sponsored Content By MassMutual
      Leveraging Data to Manage Risk
      Sponsored Content By iShares
      ETFs are becoming a cornerstone of insurance equity portfolios
    • Help us help you by supporting quality journalism
      You Must Believe in Spring
      Everything Must Change
      Tomatoes & Investments
  • Multimedia
    • Videos
    • Webinars
    • Polls
    • Slideshows
    • Charts / Infographics
    • watch video
      0:45
      Private funds weathered 2020 turmoil
      watch video
      0:59
      Secure choice and other retirement plans at a state level
      watch video
      3:33
      P&I 1,000 by the numbers 2021
      watch video
      1:33
      A look at hiring activity in 2020
    • Emerging Markets: Expanding Investors’ View
      2021: A Fixed Income Odyssey
      Technology is the New Oil: The Changing Nature of Emerging Markets
      Powering the Change: The power of diversity and inclusion
    • POLL: Working after the pandemic
      POLL: The year ahead for the 1,000 largest U.S. retirement funds
      POLL: The Biden administration’s economic plans
      POLL: Retirement issues in 2021
    • view gallery
      9 photos
      Coronavirus and the markets
      view gallery
      22 photos
      The 1,000 largest retirement funds: 2020
      view gallery
      10 photos
      Outlook 2020
      view gallery
      10 photos
      2019 as seen through the eyes of Roger
    • By the Numbers for February 2021
      Top Performing Managers of Convertibles, 4th Quarter 2020
      Top Performing Managers of Domestic Growth Equity, 4th Quarter 2020
      Top Performing Managers of Domestic Limited-Duration Fixed Income, 4th Quarter 2020
  • Events
    • Conferences
    • Webinars
    • Defined Contribution Spring Virtual Series
      DC Investment Lineup Virtual Series
      ESG Investing Virtual Series
      Private Markets Virtual Series
    • Emerging Markets: Expanding Investors’ View
      2021: A Fixed Income Odyssey
      Technology is the New Oil: The Changing Nature of Emerging Markets
      Powering the Change: The power of diversity and inclusion
  • Careers
  • Research Center
MENU
Breadcrumb
  1. Home
  2. Print
September 17, 2007 01:00 AM

Puzzling use of passive target funds

Just as DB plans gain from active management, extra effort could benefit DC participants

Matt Smith
  • Tweet
  • Share
  • Share
  • Email
  • More
    Reprints Print

    Defined contribution plan sponsors are opting for all-passive investment strategies for their default target-date funds. This choice is puzzling. After all, many of the same sponsors are choosing active management or a combination of active and passive for the defined benefit funds. Are plan sponsors living up to their fiduciary responsibility and doing what is best for DC plan participants? Why wouldn’t plan sponsors also use active management — or at least a mix of active and passive management — in their default investments?

    As defined contribution becomes the dominant employer-sponsored retirement plan in America, plan sponsors — as part of doing all they responsibly can to help ensure participants’ financial security — should choose the most effective investment structure for their default investments. In that regard, I see two trends emerging among plan sponsors. Many are selecting target-date funds as their default of choice and among those, many are choosing funds that rely on all-passive investment strategies.

    There are many factors to consider when evaluating active vs. passive asset management. Among them are cost, risk and return.

    Cost: The cost of passive managers’ operating structures is typically much lower than that of active managers. This allows them to charge materially lower fees.

    Risk: Actively managed portfolios carry the risk of underperforming their benchmark. Passive management reduces underperformance risk, but does not reduce market risk.

    Returns: The objective of active management is to generate superior returns through skillful security selection and portfolio structure. Active management is a net benefit to participants if active managers are able to generate sufficient excess return over their benchmarks to cover their fees and the cost of trading.

    From our conversations with plan sponsors, we know that many believe in the effectiveness of active management because they use it within their defined benefit plans. We assume that their decision to invest some or all of their defined benefit plan assets actively was made thoughtfully after considering the costs and benefits of the available alternatives.

    In a DB plan, the benefits of active management accrue to the plan sponsor. However, in a DC plan, the plan sponsor does not stand to gain directly from any additional return that might be generated. Further, there is extra effort involved in establishing, monitoring and managing actively managed funds within the plan. The DC plan sponsor might also perceive an additional downside: any underperformance is visible to participants and may lead to direct criticism of the plan decision-makers. As is often the case when decisions are made in the public eye and are likely to be judged critically, there is pressure to make the risk-averse one.

    Even though the underlying cost-risk-return equation of a particular investment may be the same in defined contribution as in defined benefit, there is an agency consideration that may push plan sponsors toward a different conclusion. So, if a plan sponsor believes that using an active management strategy for its DB plan assets is optimal, but then uses a passive management strategy for its DC plan assets, it begs the question of whether the sponsor is living up to its fiduciary duties and doing what is best for its DC plan participants.

    Plan sponsors who are reticent to embrace either all-passive or all-active management might want to consider constructing their target-date funds within a fee budget that allows for an active/passive mix. By opting for a multistrategy option, plan sponsors are more likely to receive the highest potential return in excess of fees when compared to an all-passive strategy.

    The case for a partially active portfolio is too compelling to pass up when the effect is examined over the course of a participant’s career. Even a small amount of additional return can make a meaningful difference. As an example, if active management add¬ed an additional 40 basis points return per year over 40 years, the additional return would result in a roughly 7% higher benefit at retirement.

    Interestingly, DC plan sponsors have faced similar challenges in the past regarding how to responsibly maximize participants’ portfolios.

    Historically, some plan sponsors relied on super-conservative investments such as stable value funds as their DC plan defaults.

    Faced with this realization and the safe harbor proposed by the Pension Protection Act of 2006, DC plan sponsors are beginning to change their defaults from super-conservative investments to more diversified choices such as target-date funds.

    Sponsors should resist pressure to choose all-passive defaults and consider default investment choices that rely on both active and passive investments. Doing so may put plan sponsors in a much stronger position when participants ask: “Did you do everything you could to ensure my financial security?”

    Matt Smith is managing director of retirement services for Russell Investment Group, based in Tacoma, Wash.

    Recommended for You
    Read the print edition of P&I
    Read the print edition of P&I
    Targeting millennials: Author, niece put his latest book to music
    Targeting millennials: Author, niece put his latest book to music
    How low is low? Projections say it's not low enough
    How low is low? Projections say it's not low enough
    How will gold react?
    Sponsored Content: How will gold react?
    sponsored
    Events
     
     
    Sponsored
    White Papers
    Shifting DC Times - Winter 2021
    Bond ETFs show maturity during Covid market mayhem
    Pension Consolidation: Optimizing Scale and Maximizing Efficiency
    China is embarking on a new stage of growth
    GP-LED OPPORTUNITIES AT THE SMALLER END OF THE MARKET
    Gold Outlook 2021
    View More
    Sponsored Content
    Partner Content
    The Industrialization of ESG Investment
    For institutional investors, ETFs can make meeting liquidity needs easier
    Gold: the most effective commodity investment
    2021 Investment Outlook | Investing Beyond the Pandemic: A Reset for Portfolios
    Ten ways retirement plan professionals add value to plan sponsors
    Gold: an efficient hedge
    View More
    E-MAIL NEWSLETTERS

    Sign up and get the best of News delivered straight to your email inbox, free of charge. Choose your news – we will deliver.

    Subscribe Today

    Get access to the news, research and analysis of events affecting the retirement and institutional money management businesses from a worldwide network of reporters and editors.

    Subscribe
    Connect With Us
    • RSS
    • Twitter
    • Facebook
    • LinkedIn

    Our Mission

    To consistently deliver news, research and analysis to the executives who manage the flow of funds in the institutional investment market.

    pilogo-NEW
    About Us

    Main Office
    685 Third Avenue
    Tenth Floor
    New York, NY 10017-4036

    Chicago Office
    150 N. Michigan Ave.
    Chicago, IL 60601

    Contact Us

    Careers at Crain

    About Pensions & Investments

     

    Advertising
    • Media Kit
    • P&I Content Solutions
    • P&I Careers | Post a Job
    • Reprints & Permissions
    Resources
    • Subscribe
    • Newsletters
    • FAQ
    • P&I Research Center
    • Site map
    • Staff Directory
    Legal
    • Privacy Policy
    • Terms and Conditions
    • Privacy Request
    Pensions & Investments
    Copyright © 1996-2021. Crain Communications, Inc. All Rights Reserved.
    • NEWS
      • Asset owners and the coronavirus
      • Alternatives
      • Consultants
      • Coronavirus
      • Defined Contribution
      • ESG
      • Frontlines
      • Hedge Funds
      • Investing / Portfolio Strategies
      • Money Management
      • Pension Funds
      • People Moves
      • Private Equity
      • Real Estate
      • Searches & Hires News
      • SECURE Act
      • Special Reports
      • WorldPensionSummit
    • Data
      • Research Center
      • Searches & Hires Database
      • Searches & Hires News
      • RFPs
      • Charts / Infographics
      • Sponsored Research
      • Trackers
    • Insights
      • Opinion
      • White Papers
      • Industry Voices
      • Letters to the Editor
      • Partner Content
      • Publisher's Update
    • Multimedia
      • Videos
      • Webinars
      • Polls
      • Slideshows
      • Charts / Infographics
    • Events
      • Conferences
      • Webinars
    • Careers
    • Research Center