Target-date funds clock another nice gain

Target-date funds continued gaining popularity in the year ended Sept. 30, with assets invested in the option reaching $122.2 billion among DC plans in Pensions & Investments' ranking of the largest U.S. retirement plans.

This represents a 26.6% increase in target-date fund assets from the year-earlier survey's $96.5 billion. That latter figure itself was a gain of almost 29% from the year ended Sept. 30, 2011.

As a result, target-date funds accounted for 13.7% of the aggregate asset allocation of defined contribution plans among the nation's 200 largest retirement plans. That compares to 11.6% and 9.6%, respectively, in the two previous surveys.

Among corporate plans, target-date funds represent 12.9% of the average asset allocation vs. 10.9% and 9.5%, respectively, for the previous two surveys. Among the public plans, the average asset mix for target-date funds was 10.9% for the current survey vs. 10.5% and 5.4%, respectively, for the previous two surveys.

Target-date fund asset growth got an obvious boost from a strong equity market in 2013, but additional inflows played a prominent role, said Josh Charlson, senior mutual fund analyst at Morningstar Inc., Chicago.

Morningstar's analysis of target-date fund assets — covering open-end mutual funds and ETF-based funds — showed year-end 2013 assets of $620.8 billion, up 28% from $484.9 billion in 2012. Of the asset growth between those years, Mr. Charlson said 37% was due to inflows and 63% was due to market appreciation.

Noting that some target-date fund managers have raised their equity allocations, Mr. Charlson said managers are “slowly beginning to think about their bond holdings” in anticipation of higher interest rates. Their response could include increasing equity allocations in their glidepaths, reducing bond-portfolio duration and/or using a “more flexible strategy” to include such investments as bank loans and high-yield bonds, he said.

Target-date fund growth is being propelled in part by younger participants in 401(k) plans. The highest target-date participation in 401(k) plans belongs to people in their 20s, according to data compiled by the Investment Company Institute and the Employee Benefit Research Institute.

In 2012, the most recent available data, 52% of participants in their 20s invested in target-date funds compared to 37% of participants in their 50s and 34% of those in their 60s.

Overall, 41% of all participants invested in target-date funds in 2012, up from 39% in 2011 and 19% in 2006, according to the ICI/EBRI research.

The percentage of assets invested in target-date funds in 2012 follows the same age trend as participation rates. Among the 20s group, 34% of their 401(k) assets were invested in target-date funds; among those in their 50s and 60s, target-date funds represented 13% of their 401(k) assets.

Overall, target-date funds accounted for 15% of 401(k) assets in 2012 vs. 13% in 2011 and 5% in 2006, the ICI/EBRI research showed.

Higher assets among younger participants can be explained in part by their target-date funds having a higher allocation to equities than funds for older workers, said Sarah Holden, senior director for retirement and investor research for the Investment Company Institute, Washington.

She said higher target-date fund use among younger employees can be explained in part by the fact that target-date funds are the most prominent qualified default investment alternative offering. Because most 401(k) plans employing auto-enrollment do so only for new hires, and because most recent hires are younger, target-date funds have become more popular, she said.

One reason younger employees are drawn to target-date funds, Ms. Holden said, is that they are benefiting from more sophisticated and detailed education from sponsors about the need for diversification and the importance of rebalancing, both of which are attributes of target-date funds. “Participants understand this (retirement savings) is for the long term,” she said. “They understand they have to stay the course.”

Target-date funds continue to dominate the qualified default investment alternative arena among the largest retirement plans, according to P&I's survey. Of the 59 plans identifying QDIA, 52, or 88%, cited target-date funds, six identified balanced funds and one reported a managed account. In the year-earlier survey, 82% of plans identified a target-date series as QDIA.

“The Pension Protection Act (enacted in 2006) accelerated this trend with more plans and more participants” relying on target-date funds as QDIA, said Nevin Adams, director of education and external relations at the Employee Benefit Research Institute, Washington.

The latest P&I survey also showed plans are offering more alternative investments as components of their target-date funds, with some alternative asset classes becoming quite common.

Among the results:

• Treasury inflation-protected securities were cited by 49 of 63 plans as being part of their target-date series compared with 47 of 49 plans a year earlier;


• Real estate investment trusts were target-date fund components in 33 of 63 plans, up from 27 of 49 plans;


• Commodities were included in target-date series for 28 of the 63 plans this year, compared with 26 of 49 plans in the previous survey;


• The number of plans using direct real estate in their target-date series grew to 15 of 61 responding to the question vs. 11 of 49; and


• Private equity, annuities and hedge funds of funds each continued to play a minor role in target-date funds with low-single-digit representation among the plans.

Morningstar's Mr. Charlson said he didn't detect any significant changes in the role that alternatives are playing in target-date funds, especially in regard to private equity and hedge fund investments. “It's a long, slow process,” he said. “Some (plan executives) are inherently skeptical of the value that alternatives can add. Some believe in alternatives, but they need to get a price and structure and managers that they're comfortable with.”