"Set it and forget it," the unofficial motto of target-date funds, became "set it and fret about it" last year as a sagging stock market, rising interest rates and flailing fixed-income investments collaborated for grim results.
Aggregate target-date fund assets dropped 13.6% to $2.24 trillion as of Dec. 31, from a record $2.6 trillion in 2021, according to Pensions & Investments' annual defined contribution managers' survey covering U.S. institutional, tax-exempt assets.
Last year's results were slightly better than the $2.21 trillion in 2020.
The S&P 500 index fell 18.1% and the Bloomberg U.S. Aggregate Bond index slumped 13% last year, illustrating that the traditional moderating force of fixed income in target-date funds' performance was an exacerbating force.
"It was a very difficult year," said Greg Ungerman, a senior vice president and defined contribution practice leader for Callan LLC, San Francisco, commenting on the "very rare" strong correlation between equity and fixed-income performance.
Research by Morningstar Direct shows the correlation between stocks and U.S. corporate bonds last year was 0.74 on a scale where 1.0 is a perfect correlation. Over 20 years, the correlation score was 0.42.
For core U.S. bonds, the correlation was 0.66 last year vs. a 20-year average of 0.14. Long-term and short-term Treasury bonds also had relatively high correlations with stocks in 2022 compared with 20-year averages.
"Last year was an outlier," said Megan Pacholok, the Chicago-based senior analyst for multiasset manager research at Morningstar Inc.
Although target-date fund vintages furthest from participants' expected retirement dates had the biggest asset declines due to the vintages' heavy emphasis on equities, retired or near-retirement participants could suffer the most, she said.
Older participants have larger fund balances, and their funds have the greatest allocation to fixed income. "They don't have as big a runway" for investment recovery as do younger participants with greater equity exposure, she said. Morningstar's target-date fund analysis covers retirement and taxable accounts, with the former representing a majority of the assets.
Among target-date providers, Ms. Pacholok said she didn't see major changes in strategies aside from some tactical adjustments in some actively managed target-date funds such as trimming equity exposure, moving to more conservative fixed-income options and shortening duration on some fixed-income investments.
None of the largest target-date fund providers to DC plans escaped the carnage. For example, assets managed by top-ranked Vanguard Group Inc. fell 14.1% to $741.1 billion. BlackRock, in second place, saw target-date assets slide 11.4% to $339.6 billion. Third-place T. Rowe Price Group Inc. suffered a 13.6% decline to $293.3 billion.
Over five years, however, target-date fund assets under management grew by 56%, according to P&I data.
Consultants, researchers and providers say the historically steady target-date growth aided by design features — auto enrollment, auto escalation, qualified default investment alternatives — should keep dollars flowing despite 2022 having been a uniquely bad year.
One encouraging sign: For the first five months of 2023, the S&P 500 stock index was up 9.6%, and the Bloomberg Aggregate Bond index was up 2.5%.
"Target-date funds are meant for a very long life cycle," said Callan's Mr. Ungerman, adding that market results so far suggest a "significant bounce-back" this year.
A glass-half-full verdict for last year was that investors who stayed with their target-date funds would enjoy dollar-cost averaging as their investments rebounded. Target-date investors don't trade as frequently as do-it-yourself investors, industry members and consultants said.
Target-date fund watchers noted that although investment declines were painful, a key metric for assessing target-date fund resilience is inflows vs. outflows.
Even if individual investors sold part of their target-date investment, plan designs mean money would still be coming in.
Last year, for example, the Alight Solutions 401(k) index reported that target-date funds accounted for the most trading outflows (53% of assets) by participants among 13 asset classes. However, target-date funds also represented the largest source of contributions (47%) among the asset classes.
Although $1.77 billion was traded out of target-date funds, $4.94 billion was contributed, Alight said.
The trading outflows were due primarily to participants seeking more conservative investments such as stable value funds, said Robert Austin, the Charlotte, N.C.-based director of research for Alight Solutions.
"We didn't see as much outflows for people taking their money out" of their institutional accounts, he added.
The inflows were a combination of auto features and more people entering the workforce, he said.
Trading was more active during the first half of 2022, then moderated. "There were no winners last year, so people slowed down" looking for other investments, he said. "There was no real clear path where you should go in 2022."
By contrast, in 2021, outflows from target-date fund trading exceeded inflows via contributions — $5.22 billion for the former vs. $4.97 billion for the latter. "People were rebalancing" because equities were strong that year, Mr. Austin said.
Early returns this year show some rising confidence as trading is starting to pick up a bit, he said. For the first quarter, target-date fund trading outflows were $310 million while contributions were $2.6 billion.
The Alight 401(k) index reflects activity of more than 2 million participants with more than $200 billion in Alight record-keeping accounts. The target-date category also include some target-risk assets, which account for less than 10% of the total.
Target-date funds remain the largest category in the Alight 401(k) universe with 29.9% of assets last year, followed by large-cap U.S. equity (25.7%) and stable value (9.6%) as of year-end 2022.
Target-date funds are ubiquitous among DC plans for which Vanguard is the record keeper: 96% of clients offer a target-date series; 40% of record-kept assets are allocated to them; 83% of participants invest in them when offered; and 63% of all contributions are directed to target-date funds. Each figure for 2022 is a record, according to Vanguard's just-published annual How America Saves report. The report covers 1,700 plans, record-kept by Vanguard, with approximately 5 million participants.
Seventy-one percent of participants held a target-date fund as their sole retirement account investment last year, also a record. Among plans that offer a qualified default investment alternative, 98% of the QDIAs were target-date funds and 2% were balanced funds in the Vanguard universe.
Vanguard didn't make any changes last year to its target-date series glidepath or underlying investments, said Brian Miller, the Malvern, Pa.- based senior investment specialist and head of target-date product management. Mr. Miller attributed the AUM decline to market depreciation.
"We do a full re-evaluation each year," he said. "It's constant research but not constant change. We don't want to overreact."
Questions from clients focused primarily on asking Vanguard to provide talking points to participants about inflation and high interest rates, he said.
Last year, an estimated 2.3% of participants in retirement accounts moved out of target-date funds with some seeking riskier assets and others seeking more conservative assets such as stable value, he said. In a typical year, 1% to 1.5% of participants move out of target-date funds.
Last year, "Investment contributions were right on par with historical trend," Mr. Miller said.
The average deferral rate was an estimated 7.4% of salary last year — the same as in 2021 — for all retirement investments, said the Vanguard report. The median rate was 6.4% for both years. Vanguard's counting excludes eligible employees not contributing to their plans.
"Did target-date funds do their job in 2022? I can say 'yes,'" Mr. Miller said. "Did they help people stay the course? Yes."
T. Rowe Price didn't make any changes to the glidepaths or underlying investments, said Wyatt Lee, a Baltimore-based T. Rowe Price vice president, who is head of target-date strategies in the global multiasset division and co-manager of target-date portfolios.
The AUM decline in 2022 was all market-related, Mr. Lee said, adding: "There was no place to hide."
The last changes in target-date equity components came in 2022 and the last adjustments in fixed income occurred in 2017 and 2018. "We were very well-positioned in 2022 for the changes we made previously," he said.
Mr. Lee said the company's target-date franchise had net inflows last year of about $11 billion, similar to 2021. The new money came from some new clients and from ongoing contributions from participants in its record-kept plans.
Defined contribution participants don't trade often, he added, and target-date investors trade even less frequently.
Despite lower target-date fund and overall defined contribution AUM, BlackRock still managed to add about $18 billion in net inflows last year, mostly in its index target-date funds, said Nick Nefouse, the New York-based managing director and global head of retirement solutions. Much of that gain came via new clients and QDIAs. The AUM decline was market-related, he said.
BlackRock didn't change its target-date glidepath, but it adjusted the fixed-income component. "Prior to 2022, we used a single nominal fixed-income building block," said Mr. Nefouse, referring to the Bloomberg U.S. Aggregate Bond index.
"Now we use five building blocks to give us more precision within the nominal fixed-income allocation," he explained. "The allocation to building blocks is based on where the investor is in the glidepath."
The five components are long- duration government bonds, long- duration corporate bonds, intermediate-duration government bonds, intermediate-duration corporate bonds and securitized fixed income, such as mortgage-backed securities.
Despite the overall decline in target-date assets last year, some trends continued without interruption.
The year-end asset-weighted expense ratio dropped to 32 basis points last year vs. 34 basis points in 2021, part of a steady annual decline from 60 basis points in 2013, according to Morningstar Direct.
Collective investment trusts kept eroding mutual funds' dominance in target-date funds, accounting for a 47% market share last year vs. 45% in 2021 and 37% in 2018. CIT-based target-date fund growth has contributed to lower target-date fund fees, Morningstar reported.
Most of the new money flowing into target-date funds came from CITs last year — $121 billion vs. $32.3 billion into mutual funds, continuing a trend, Morningstar reported.
The latest annual defined contribution survey by Callan found that sponsors are eschewing actively managed target-date funds for index-based options or combinations of passive and actively managed target-date funds. Last year, only 15% of target-date funds were actively managed, about half the rate in 2012 and the lowest rate in the 16-year history of Callan's DC survey.
(The latest survey, conducted in late 2022, contained responses from 99 large DC plans, a mixture of clients and non-clients.)
The survey noted that 97% of respondents reported target-date funds as the QDIA, up from 35% in 2006 when the Pension Protection Act was enacted.
When asked what actions they took in 2022 or will take in 2023 regarding target-date funds, the biggest response to both questions was no change — 38% last year and 33% for this year. Respondents were given eight choices, and multiple answers were allowed.
Second-place answers were evaluating the glidepath (35% in 2022 and 25% in 2023). Third-place answers were evaluating underlying investments (25% last year and 15% in 2023).
