For many defined contribution (DC) plan sponsors, offering target date funds1 as a qualified default investment alternative (QDIA) has become almost expected. A target date fund invests based on a particular date, such as the year of a participant’s projected retirement.
Not surprisingly, target date funds (TDFs) have garnered the largest share of the DC plan market. Seventy-two percent of large to mega-sized 401(k) plans use them, according to recent research2. TDFs’ widespread uptake in DC plans also accounted for 68% of the record $790 billion in mutual fund TDF assets reached in the first quarter of 2016, the Investment Company Institute (ICI) found.Further, 69% of participants use TDFs, according to a well-known survey.3 However, some industry experts are concerned that existing TDFs may not be keeping up with today’s best practices, fiduciary standards and new innovations in investment product design.
The key concern: target date strategies and glide paths that rely on traditional stock and bond allocations may not deliver enough investment growth over time, creating a shortfall for many individuals at retirement. That’s because existing strategies are ill-equipped to mitigate risks such as below-average investment growth, and market, inflation, and longevity risks.
The TDF of the Future
Some experts say the next generation of TDF designs must evolve from single-manager, static allocations that offer only active vs. passive strategies and “to” retirement glide paths, and instead include:
- multi-manager/open architecture structures
- a more diverse mix of nontraditional asset classes
- dynamic allocations that respond to short-term market fluctuations
- a mix of active and passive investing strategies
- “through” retirement glide paths designed to deliver better distribution phase outcomes
Interestingly, participants’ preferences seem at odds with current industry practices for TDFs, further justifying a move away from existing designs, according to a recent white paper from Voya Investment Management. Seventy-five percent of participants said their TDF’s investment architecture should include multiple managers; only six of the 25 largest target-date managers allocate to non-proprietary active funds.
Additionally, 79% of participants surveyed said they wanted additional market exposure via an array of asset classes, however, diversification levels vary widely in the industry, from five to seven asset classes for many passive TDF providers to 15 to 20 for those who offer more blended or active strategies.
TDFs Present Opportunities
Nonetheless, TDFs still present opportunities for plan sponsors to increase participation by using them as a QDIA, implementing auto enrollment and auto escalation to increase savings, and engaging with participants by educating them about the benefits of TDFs. With enhancements like those envisioned in the research cited here, TDFs will likely continue to be a QDIA option for many retirement plan participants.
Read Voya’s TDF research here: http://tinyurl.com/voyaTDFstudy.
(1) Remember that the principal invested in a TDF is not guaranteed, even at the specified target date.
(2) Designing the Future of Target-Date Funds, 2017 Alliance Bernstein LLP, http://tinyurl.com/ABTDFfuture
(3) How America Saves 2016, Vanguard, https://pressroom.vanguard.com/nonindexed/HAS2016_Final.pdf
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