The beat goes on for target date fund growth (TDFs) which saw the largest net gains in 2015 since their inception according to Morningstar. It’s the single most important investment for defined contribution (DC) plan sponsors to understand and focus on which means that the process of selecting and monitoring TDFs should be different than any other investment.
TDFs have done a great job managing behavior and protecting investors from themselves. Investors in most types of mutual funds do worse than the fund’s returns because they sell low and buy high. But investors in TDFs actually do better than the funds return by .74%. Compare that to investors in international equities that do 1.24% worse and you get the picture.
At $763 billion by the end of 2015, target date fund growth enjoyed its best year gaining $69 billion. Costs continue to plummet from .78% in 2014 to .73% in 2015 and 1.03% in 2009. While mutual funds are the most popular form of TDFs, collective trusts (CITs) are quickly gaining in popularity with assets in Blackrock’s CIT’s dwarfing their mutual fund offering. Though CITs require less disclosure, they also lower costs which is a huge factor in determining returns.
With so much money flowing into TDFs (some estimate that 70% of new DC plan contribution flow into these types of investments), they not only require more attention but they require an entirely different analysis than other types of investments. Because they are a pool of investments, they should not be analyzed like individual funds or stocks. And because investors tend to stay in TDFs longer, DC plan sponsors should be matching the behavior and demographics of their workforce with the right TDF.
Some experts advise that plan sponsors should first conduct a search for the right TDF and then determine which record keeper they should use that offers these funds. Many providers that have TDFs offer discounts on record keeping and other administrative services which is fine as long as the analysis of TDFs are done independent from reviewing the provider.
Along with better returns and behavior as well as declining costs, the reason that target date fund growth has accelerated so quickly in the last 10 years is because of the 2006 Pension Protection Act which provided safe harbor to DC plan sponsors that offer TDFs as the default option for automatically enrolled employees. With auto enrollment and auto escalation growing, look for TDFs to follow.
