Plan sponsors get serious about TDF selection

As target-date fund assets continue to skyrocket and as more 401(k) plans adopt auto-enrollment, plan sponsors are taking a taking a more measured approach to choosing the TDFs for their plans.

“We see auto-enrollment trends going up over the past few years and we don’t expect that to stop,” says Brooks Herman, head of data & research at BrightScope, an investment research provider. “More and more 401(k) plans are embracing auto-enrollment and that’s going to push the growth of target-date funds.”

TDF assets account for $700 billion in mutual funds alone, a 12% increase over last year, according to BrightScope’s most recent report on TDFs, released today. Noteworthy trends include a continued downward pressure on fees and changes in distribution.

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“When we first looked at target-date funds in 2011, the average [fee] for the institutional share class was 72 basis points and now fees are at 65 basis points,” says Herman. “So target-date funds are getting cheaper. That’s good for plan participants.”

And, as auto-enrollment escalates and more plan sponsors choose TDFs as their qualified default investment option, TDF assets will continue to grow, says Herman. “We see auto-enrollment trends going up over the past few years and we don’t expect that to stop,” he says. “More and more 401(k) plans are embracing auto-enrollment and that’s going to push the growth of target-date funds.”

And while many 401(k) plan sponsors used to be quite beholden to the recordkeeper, “what we’ve seen over the past several years is that plan sponsors are getting very serious about the target-date fund selection for the 401(k) plan,” says Herman. “And it turns out the target-date fund offered by the recordkeeper might not be the best target-date fund for that plan. And the 401(k) plan sponsors are going off-platform to meet the needs of their participants.”

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In BrightScope’s database of 10,000 401(k) plans, “we see a drop in [the use of] proprietary target-date funds over the past four years from 57% to about 50%,” says Herman. “We’re seeing a real drop in plan sponsors using the recordkeeper’s own target-date funds.”

The BrightScope research looked at the lowest cost institutional share class for all target-date funds through February 2015. This included 59 target-date series, comprised of 561 distinct target-date funds from 40 different asset managers. The report also looked at market entrants and exits. One interesting exit, says Herman, was iShares.

“Everyone keeps talking about the prominence of exchange-traded funds entering the 401(k) world and [how] it’s going to be a game-changer … and i-Shares couldn’t make a go of it,” says Herman, adding that Deutsche Bank also announced recently that it is liquidating its ETF target-date fund.

“No one’s quite cracked the egg yet on how ETFs are going to work in this retirement market,” says Herman. “That’s still a work in progress.”

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Technology challenges are one of the main reasons ETFs haven’t yet broken into the 401(k) space, says Herman. “There’s a big technological change for the recordkeepers if they want to recordkeep ETFs and have transactions go on throughout the day,” he says.

Fee competition could also be hindering wider ETF adoption in 401(k) plans. “Collective trusts in the institutional share classes are going to compete with ETFs on fees,” Herman says. “If you have a Vanguard institutional class, for example, or other institutional share classes, they’re going to be just as competitive with ETFs on fees, if not more competitive.”