Passive target-date funds? No such thing

Glide path requires active decisions from a manager

Mar 17, 2018 @ 6:00 am

By John Waggoner

If your clients ask for a passively managed target-date fund, you might have to explain to them that there's no such thing — although you should certainly steer them to a low-cost target-date fund.

Passive investing has taken investors' fancy as well as their money. In January, for example, investors poured an estimated $41.2 billion into passively managed stock funds and ETFs and yanked $24 billion out of actively managed funds, according to Morningstar Inc.

But target-date funds, by their nature, aren't passively managed. Each target-date fund has a "glide path," the industry term for the percentage of stocks in the fund as the fund approaches its target date. Just how quickly the equity exposure is lowered is one active decision.

"Any target-date manager is making certain decisions: Those are basically the glide path decision, but also on sub-asset classes within the fund," said Jeff Holt, Morningstar's director of multi-asset and alternative strategies for North America.

Lots in stocks

For example, Vanguard Target Retirement 2030, the largest fund in its category, has 69.6% of its assets in stocks, according to Morningstar. Fidelity Freedom 2030, the second-largest in the category, has 75.4% in stocks. In that narrow category, the percentage in stocks varies from 81.3% for Wells Fargo Dynamic Target 2030 to 18.1% for Columbia Active Retirement 2030.

"At the end of the day, managers are expressing their investment philosophy through target-date funds," Mr. Holt said.

Increasingly, funds are diversifying out from just a mixture of stocks and bonds, although that mixture is one of the primary drivers of performance. At T. Rowe Price, which swept the target-date category for the Thomson Reuters Lipper Fund Awards this year, managers have been adding new elements into the mix, said Joe Martel, a portfolio specialist in the Multi-Asset Division of T. Rowe Price. "Things such as inflation hedges, high-yield and emerging markets debt can improve the outcome for participants," he said.

Inflation hedge

Some target-date funds are also adding strategies employed by endowments and pensions. T. Rowe Price, for example, has added a real return sleeve to some of its target-date funds, a strategy that involves real estate, energy and metals as an inflation hedge.

Another reason for the variation among target-date funds is what the fund will do when it reaches its target date. Some funds simply become income funds; others figure that retirees will be invested in the fund for their entire retirement, which can be 35 years for someone who retires at 65 and dies at 100. The difference between those that manage up to retirement and those that manage through retirement can be substantial —– and again, this is an active management choice.

For example, Fidelity Freedom 2010 (FFFCX) currently has 42.3% of its assets in stocks, even though its target date is eight years in the past. The fund takes a modified "through" approach — its portfolio will come to mirror Fidelity Freedom Income Fund in 10 to 19 years after is target date. Dimensional 2010 Target Date Retirement Income Fund DRIBX has 21.6% of its assets in stocks.

So is there such a thing as a passive target-date strategy? No.

"From our perspective, while you can have passive investments in a target-date fund, designing the glide path and diversification decisions are active decisions and will have big influences on the outcome of for investors," Mr. Martel said.

When people talk about passively managed target-date funds, they typically mean target-date funds that invest in passively managed index funds, such as Vanguard's target retirement series or the BlackRock LifePath Index series.

"But if you look under the hood, they will be very different," Morningstar's Mr. Holt said. "They both have differing views on how to build a portfolio."

Still growing
Total assets in target-date mutual funds, in billions

Using passive investments in a target-date fund helps lower fund expenses, one of the critical factors in fund performance, particularly over the long term — which is what target-date funds are expressly designed for.

"It's apparent that investors are gravitating to low-cost target-date funds, and those are usually ones that own index funds," Mr. Holt said.

(See other stories from the latest Retirement Plan Adviser here)


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