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Special report: target-date funds

Europeans seeing funds as solution to DC dilemma

Strategies gain traction as sponsors look for answers to more regulation

Anthony Charlwood said his firm added target-date funds to help participants.

The growth rate of target-date funds is accelerating in Europe as the budding regulatory and investment agendas of European governments continue to push plan sponsors toward more adequate defined contribution plan designs.

In the U.K. — one of the more mature and competitive European defined contribution markets, according to estimates by DC consultancy Spence Johnson, a Broadridge company — target-date funds could hold some 25% of all U.K. defined contribution assets by 2026. That's up from 2%, or 6.8 billion, in 2016. The U.K.'s defined contribution market is projected to be 871 billion in 2026, up from 338 billion in 2016.

This dramatic shift in market structure is anticipated because target-date funds can help plan sponsors manage an influx of regulatory demands, in addition to offering benefits such as simpler participant communication or access to new asset classes, sources said.

Plan executives prefer target-date funds because they offer operational efficiency and regulatory risk management, and are being treated as custodians of assets rather than investment options.

In the aftermath of the U.K.'s pension freedoms regulation in 2015 — which effectively removed the requirement to purchase an annuity to provide income in retirement — the management of volatility at different stages of the retirement investing glidepath has become a key consideration for plan executives, leaving target-date fund providers in a sweet spot.

An additional opportunity is emerging, sources said, since transaction cost disclosure is now required under a Financial Conduct Authority regulation adopted late last year. Managing and switching assets in lifestyle strategies is more costly than in target-date funds, due to consultant and administrative charges, giving plan sponsors another reason to turn to target-date funds when they begin reporting transaction costs in April.

That's what happened after the pension freedoms enactment, sources said; target-date funds became a useful tool in managing retirement outcomes once buying an annuity no longer was required. As plan participants increasingly began to opt for cash, plan sponsors moved to help them manage those retirement pots.

One such sponsor is the Pensions Trust, London. Anthony Charlwood, investment manager, said the trust's 1.07 billion ($1.5 billion) defined contribution plan added target-date funds after the pension freedoms to help participants. "Over a year ago we adjusted the glidepath for participants who were approaching retirement date and were predominantly taking their pots as cash. We are (now) invested mainly in very short-term bonds. But we have retained a 20% exposure to passive equity," Mr. Charlwood said.

Regulatory drivers

Managers report similar regulatory drivers in France's retirement market. The French government passed a law in 2015 that allowed money managers to increase private market allocations in target-date funds to as much as 30% from the prior 20% cap, and managers have used this opportunity to bring more target-date funds to the corporate plan market.

"Target-date funds are popular with clients because they offer a simplification of retirement management in the multinational company," said Delphine di Pizio-Tiger, head of employee savings and retirement management at Amundi in Paris.

Amundi's target-date assets under management for French companies rose to €5 billion ($6 billion) since being launched two years ago, she said.

The firm offers target-date funds in eight European countries, including Germany and Italy, where corporate plans appear to be driving the demand. Ms. di Pizio-Tiger said budding regulatory agendas in other European countries have prompted Amundi to extend its offering to Ireland and Austria. The Irish government this year has proposed adding a mandatory defined contribution program to its retirement system in 2020 and an auto-enrollment program starting in 2022. In Austria the government is gearing up to vote on legislation that would require plan sponsors to incorporate environmental, social and governance factors into the default strategies.

Sources said target-date funds in the U.S. were a success because they appeared at a right time. They think there could be a similar situation now in Europe due to the flurry of new and proposed regulations.

More recently, the European Commission proposed a pan-European personal savings product that will allow mobile workers to save into cross-border retirement plans. One such plan, the Retirement Savings Vehicle for European Research Institutions, Brussels, is open to using target-date funds for the pan-European option, said Filip Hemeryck, senior consulting actuary at Aon in Diegem, Belgiu, which is assisting in the search. RESAVER is expected to build assets to €100 million by 2022.

Enhancing lifestyle funds

In the U.K., however, where target-date funds have had a more fertile ground to mature compared to other, younger European DC markets, some of the local investment industry remains undecided on the move. Many players, including plan executives themselves, are still toying with the idea of improving lifestyle funds rather than adding target-date funds.

Hugh Skinner, head of DC investment at Fidelity International in London, said his firm is working on enhancing its lifestyle strategy through the high-risk growth phase to incorporate an allocation of 70% to global equity and 30% to a dynamic multiasset fund consisting of highly liquid diversified assets. Mr. Skinner said the aim is to enable exposure to the growth potential of equities alongside the volatility control of the multiasset fund.

While sources cited administrative simplicity for participants as a key benefit of target-date funds as far as adoption triggers are concerned, easier access to illiquid investments that are unavailable through lifestyle strategies resonated more with retirement plan executives and their consultants.

Maria Nazarova-Doyle, head of DC investment consulting at JLT Employee Benefits Ltd. in London, said the ability of target-date funds to include illiquid strategies has been a key selling point for consultants in the U.K.

Still, Jonathan Libre, senior analyst at Spence Johnson in London, said target-date funds aren't expected to fully replace lifestyle strategies.

Spence Johnson estimates some 60% of U.K. DC assets will stay in lifestyle strategies. Total DC assets will grow to 871 billion from 338 billion in 2016, according to Broadridge estimates.

The 2 billion multiemployer plan the People's Pension, West Sussex, England, does not use target-date funds. "Target-date funds in the U.K. becoming a third of the market is an overestimate," said Nico Aspinall, chief investment officer.