Passive investing gets some action in target date funds

JUL 16, 2013
Investors' love affair with passively managed funds has spilled over into target date funds as investors and portfolio managers alike have embraced indexing. Passively managed target date funds outsold actively managed target date funds for the first time last year, according to Morningstar Inc. Passive target date funds took in $28.7 billion last year, up from $18.6 billion in 2011, trumping actively managed target date funds' $26 billion in inflows, according to the research firm. Actively managed target date funds' market share dropped to 68%, from 85% in 2006. At the current pace of inflows, passively managed target date funds are set to overtake actively managed ones by 2019. “It's a trend that's been accelerating, and it reached a tipping point last year,” said Josh Charlson, a fund-of-funds strategist at Morningstar. The biggest beneficiary of the shift is The Vanguard Group Inc., which created the first index fund. Vanguard has been running laps around the asset management industry since the financial crisis, thanks to its low-cost mantra, so it's no surprise that its passively managed target date fund series took in approximately $19 billion of the $28.7 billion in total inflows into all funds last year. Other firms have climbed onto the passive target date bandwagon, as well. Defined-contribution bigwigs Fidelity Investments, BlackRock Inc. and TIAA-CREF have all launched passively managed target date fund series in the past five years. They took in the rest of the $9.7 billion in total inflows into such funds. J.P. Morgan Asset Management launched an almost all-index target date fund series last year. Its SmartRetirement Blend target date funds have only about 37% of assets allocated to actively managed funds, according to Morningstar. “It's recognition by firms of the cost competitiveness in the industry,” Mr. Charlson said.

HALF THE PRICE

The asset-weighted average passively managed target date fund costs 47 basis points, or about half the price of its actively managed counterpart, according to Morningstar. Some companies, such as Vanguard and Fidelity, go much lower with their pricing. They charge 18 and 19 basis points, respectively, for their passively managed target date funds. Lingering uneasiness following the downturn of 2008 has caused some actively managed target date funds to up their exposure to index funds. Both MassMutual Financial Group and MainStay Investments increased the allocation to passively managed funds inside their target date fund series by double digits in 2012, according to Morningstar. MassMutual now has around a 10% allocation to passive funds, up from zero in 2011, and Mainstay allocates around 33% to index funds, up from 22% in 2011, according to Morningstar. ING U.S. Investment Management and Principal Financial Group both increased their passive exposure by around 5 percentage points, to 15% and 16% of assets, respectively. “The key is consistency,” said Bruce Picard, lead manager of the MassMutual RetireSmart target date funds. “Index funds are a useful tool. You know you're going to participate in the returns of the asset class, for better or worse.” MassMutual added international equity, midcap and small-cap index funds to its investment mix in mid-2012. It still allocates to active managers in all three asset classes on top of the index fund exposure. “It allows you to have asset class exposure in place, and then you can hire active managers to take more risk,” Mr. Picard said.

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