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Caution: Avoid Target Date Retirement Fund Oversimplifications

NEW: Bonus Question

Question: Why does Morningstar track manager ownership in Target Date Retirement Funds and what could it tell you?

Jeff Holt: Generally, investors should expect portfolio managers to invest alongside them because it helps align interests.  If portfolio managers don’t have enough conviction to invest in their own strategies, why should investors hold those strategies?  For target-date funds, manager ownership may indicate a manager’s preferred approach if he or she runs multiple series.  It may also indicate when a target-date manager expects to retire, raising questions with succession planning.  

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With Guest:
Jeff  Holt, CFA
Director, Multi-Asset & Alternative Strategies
Morningstar Research Services, LLC

Jeff Holt, CFA, is director of multi-asset and alternative strategies for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He covers target-date funds and other multi-asset funds from various asset managers.


Before joining Morningstar in 2014, Holt spent nearly nine years at Jeffrey Slocum & Associates (since acquired by Pavilion Financial), where he was responsible for investment research to support the firm’s defined-contribution practice. He covered target-date funds, stable value funds, and other asset classes specific to defined-contribution clients.


Holt holds a bachelor’s degree in management, with a concentration in corporate finance from Brigham Young University. He also holds the Chartered Financial Analyst® designation.

Recap, Highlights, and Thoughts

After a quick hiatus in July, we are back and excited about what we have in store! To kick things off, this episode features my conversation with Jeff Holt, CFA and Director, Multi-Asset & Alternative Strategies 

and the lead author of the annual Morningstar Target Date Landscape Report.  This is the third time Jeff has been on the podcast and his return does not disappoint.  The broader theme of our conversation was the importance of avoiding oversimplifications when evaluating target date funds.  As you will hear, this ranges from cost, glide path, the classic too vs. through distinction, mutual funds vs. CITs and many more.  With the prevalence of target date funds in workplace retirement plans, I thought this would be a great way to get things going again.  


A few tweaks to look forward to going forward.  First, we will provide a transcript (below) for each episode.  Second, each guest will provide a written answer to a bonus question (above). 


Here is the link to the 2019 Target Date Landscape Report we discussed today. 


If you have any other ideas to improve the podcast please share them with me via email,

Thanks for listening!​​

Sincerely Your Host, 

Rick Unser

NEW: Episode Transcript

Rick Unser:    Well, Jeff, welcome back to the podcast. It's been a year, and, coincidentally, you've got another target-date report, so I'm really looking forward to chatting with you and hearing what you have to say is going on in target-dates these days.


Jeff Holt:    Well, thanks for having me back, Rick. Happy to talk about target-date funds.


Rick Unser:    Always a fun conversation and as more and more assets move there, it becomes a more and more important conversation. As I alluded to there, I know you and Morningstar have put out a target-date report for the last several years and I guess in this report, is there anything that jumped off the page or that was just a material ah-hah moment that was new or that you guys picked up on for the 2018 version?


Jeff Holt:    I think the biggest thing that jumped out as we were putting together the report and combing through all the data... what wasn't a surprise was that target-date funds continue to grow, but what was a bit of an eye-opener was how much price of a target-date factored into its growth. And so, generally, for target-date mutual funds in 2018, they saw roughly $55 billion in net flows from investors in that year, and so it's been more than a decade of consistently strong growth from investors, and strong flows.

So seeing strong growth to target-date funds wasn't a surprise, but was a surprise is, when we broke it down, the growth by the target-date fund, and did it by their expense ratio, and when we did that, $57 billion of net inflows went to target-date funds with expense ratios less than or equal to 0.20% or 20 basis points or lower, and so that exceeds even that overall net $55 billion because other, more expensive, target-date funds are out flows. And so, on that side, when you look at target-date funds that had expense ratios higher than 60 basis points, or 0.60%, those saw net outflows of $37 billion, and so just the magnitude of seeing how much of the flow of new money that has gone to the low-cost options, versus how much money is coming out of higher cost options, really stood out as we were pulling together the report this year.

Rick Unser:    And on that note, I guess, is that a good thing or does that maybe indicate something else that you guys are seeing in the grander target-date landscape?

Jeff Holt:    That's a good question. Is it a good thing? So, generally, lower cost is a good thing, right? Investors, they keep more in their pocket, they're not paying as much in fees to the managers to run the money. The complication when it comes to target-date funds though is, as we look at the portfolios, the glide path and all the other aspects of target-date funds, you can see that they're not all the same, and so lower cost is definitely a benefit, assuming that the strategies are very similar or equal, but when they're not similar, I mean, you have to factor in those other aspects as well. But, generally, the trend to lower cost is a positive trend for investors, but it is important that it's not the only aspect that's being considered into selecting a target-date series.


Rick Unser:    Yeah. And I guess I'm kind of glad we're starting here because I think that is one of the things that I definitely see out in the market, is when investment committees who are overseeing workplace retirement plans and making decisions about their plans and sometimes they're talking about millions of dollars, tens of millions, hundreds of millions of dollars that are involved, or invested, in these target-date strategies and there still seems to be a very strong preference to cost as maybe not the only determinant but a major determinant of, well, should we go with this one or that one, when it comes to our target-date strategy.


Jeff Holt:    And I think that's the potential danger we see in the trend. Again, low fees, generally, is a great thing, investors keep more in their pockets, it cuts out less of what the return experience they're going to achieve with that fund, but it is important that plan sponsors and investors don't forget about the other aspects that are also going to have potentially even a more meaningful effect on the results than the expense ratio.


Rick Unser:    And I just have to steer into that comment, what can be more meaningful than just, hey, this one is 15 basis points on the average versus this one's 22 basis points on the average.


Jeff Holt:    One of the things we emphasize in the [inaudible 00:04:28] Landscape Report this year is that we actually titled the report, Simplifying the Complex because the expense ratio tends to be one of those areas that it's fairly straightforward. Every fund as an expense ratio. You can compare one expense ratio to another and see which one's better. There's other areas of target-date funds that have become more complex to evaluate and often it's because of the features that are unique to target-date funds that make them attractive as a set it and forget it, all in one solution for retirement assets, like the glide path, and having different funds along the glide path. That's what makes it more complex to evaluate. And so one of the goals, as manager research analysts at Morningstar, we evaluate these target-date series and we're talking with the portfolio managers and there's certain data and detail that we want to feel like we're getting an appropriate amount of depth into the strategy. And one of those areas we stress is looking at not just the strategic equity glide path but actually the sub-ass class glide path, and what means is, at the top layer, two series can look very similar, under strategic equity glide path, and looking how the equity allocation changes over time, based on how they're going to reflect in their perspective. But what the sub-ass class glide path really dials down into is looking at each individual holding, not just the underlying fund that they're holding, but actually the underlying security that those underlying funds are holding. We've identified 10 sub-ass classes and mapping them to each other to get a sense of how the glide path is really built, because in addition to just the equity bond split, portfolio managers of target-date funds are making decisions on how much to include in U.S. versus non-U.S. equity, how much to include in emerging markets equity. On the bond side, there's also decisions when to include tips into the portfolio, how much in high-yield bonds or foreign bonds. So all these decisions, what it ends up making is, because these portfolios are so different, it makes the performance experience different, and so we've highlighted multiple instances. And it's even the case when you look at series that invest in index funds, that if you compare two that look, on the surface, very similar, like in the case of a Vanguard and a State Street target-date series, but if you look at the sub-asset classes, you're going to see significant differences that are really going to drive results. So that's just an example of highlighting how other aspects, in addition to price, because, like in that case with Vanguard and State Street, I mean, they're going to both be in that low-cost area because they're both [inaudible 00:06:50] index funds but investors are going to have different experiences because the portfolios look very different, and even if the strategic equity glide paths look similar, the portfolios look very different. So, again, that's just an example of areas that requires peeling back another layer to really get a good sense of what's going on with the target-date series.


Rick Unser:    Very well said, and I think, as you were talking there, and as I'm thinking about some of the conversations that happen in some of the committee meetings and committee rooms that are making these decisions, you're exactly right. Comparing expense ratios, man, that's pretty darn easy: this one's x, this one's y. That makes sense. Taking that next step and getting to that strategic equity glide path, okay, now we're going one step deeper here and there's some subtleties there, there's some interpretation there, but as you get to that underlying sub-asset class level, I think that's a level of depth I don't know that everyone is going through the analysis today and... What would you point to as a couple of major reasons to really take that extra time or take that extra step and say, "Yeah, you know what? I get it," like you were saying, "a lot of these look really similar, but here's why this is important and here's how the outcomes or the results might be different for your employees, for your participants, if you take that extra time to look at some of those sub-asset classes."

Jeff Holt:    So I think what the benefit is, by looking at the sub-asset classes, is that it helps put past performance in proper perspective and it also will help you set expectations for performance going forward. So when we've expressed, and we're showing in our new target-date series reports that we publish for our target-date series that we cover by analysts, is, if you run a sub-asset glide path for all the target-date series, and then once you run for all of them, you create an average, a pure average sub-asset class glide path. And then once you have that, you can basically layer on top of what that series glide path looks, compared to the average, and you can get a really good sense that when and where along the glide path a series is overweight or underweight at a particular asset class. So an instance, just a hypothetical example. If you know a target-date series is heavily overweight in U.S. large cap equities across the glide path and you look in the hindsight and you see that U.S. large cap equities have been the best performing asset class, you can surmise that that's what driving performance, and if that target-date series and those funds in that target-date series have not performed well, and despite having a huge tailwind by being overweight in the best performing asset class, that's a problem, right? That's something that you can identify by looking at the sub-ass glide path. And so what the sub-asset glide path really does is, it helps provides information to really put past performance in proper context and help set expectations for future returns so that plan sponsors or investors aren't coming to a conclusion that, if a series has done really well, like [inaudible 00:09:55] saying, because it's overweight, an asset class that has done really well, well, that might not persist over the long run, or it might reverse and so performance might change over time. So, again, it just provides more knowledge and more power on understanding what's going on with results, and that's why, from our perspective, we think it's of utmost importance to be digging into the sub-ass class glide path.


Rick Unser:    Really well said, and I think there are some examples out there in the marketplace today of exactly that happening, so I think that's a really important thing and I really like the way you said that there.


Jeff Holt:    I mean, because as we've seen with the attention to low-cost target-date funds, we've seen part of the funds that have gotten the most flows or seen a big traction have been target-date funds that have invested heavily in index funds because that's one way for lower costs, is by investing more heavily in index funds. But when we look at target-date series that invest in index funds, you compare them from the sub-ass class glide path exposure, they look wildly different. Similar expense ratios, both invest in index funds, but, again, they look very different in the sub-ass class exposures which is going to produce different results versus different series, and so target-date funds is a space where there's no path of option out there. I mean, because there's a glide path decision, there's sub-ass class glide path, sub-ass class decisions, underlying exposure decisions, and so what the sub-ass class glide path does is, it provides the more insight on to really highlighting what the major differences are between the series.


Rick Unser:    Yeah. No, no, very well said. Just sticking on that theme for a second there, are there any other major ways that either in your report or that you would just suggest a plan sponsor look to find differences between different target-date strategies?


Jeff Holt:    I think the important thing to do when evaluating target-date funds is to look across the different aspects, and as I mentioned earlier, sometimes there's complexity to target-date funds because there are multiple funds and they shift, but it's important to look at the process. When I say the process, I'm talking about the strategic equity glide path, look at the sub-ass class glide path. Also look at the underlying funds and the exposure to those funds. Are they good funds? Are they heavily weighted in one particular fund that if that fund did poorly it would affect the whole target-date fund? Also looking at tracking. We've added some new exhibits and new data to our reports that helps investors track, as underlying funds come in and out of target-date funds, to get a sense of what changes the target-date managers are making. And so that's all under the process aspect, but then you also want to evaluate the people, look at who are the people that are behind the scenes, making the decision for the target-date funds. Are they invested in the series? Do they manage multiple series? Do they have other responsibilities within the firm, to get a sense of how much attention they pay to target-date funds versus other areas. And so you look at it through the process, you look at it through the people, you look at the general firm, we call it the parent, to get a sense of how important target-date funds are to the parent. And then you do look at price and you look at performance to see how those stack up as well, but, again, I would say the emphasis for target-date funds, from a plan sponsor perspective, should be on really understanding the approach behind the series and understanding who are the people making those decisions because we have found, and we put in the 2019 Landscape Report, that roughly half of all target-date series in 2018 saw a manager change on their portfolio manager roster. So we are seeing changes. The nice thing is that we're also seeing that most target-date funds have... well, actually, all target-date series have multiple managers now so it's not just one individual generally making all the decisions, and so it is diversified, but it's still one of those things that it's important to track that history of portfolio managers and who's making those decisions because, again, for investors in target-date funds, this could be a multi-decade investment and so it's really of utmost importance to be in a series that can be expected to do well over the long run.


Rick Unser:    One random observation, and I guess maybe this is back on process, I read your report cover to cover, again, I thought it was great, there wasn't a mention, or at least one that I saw, of two versus through. That was something I feel like was really important several years ago. Is that even part of the vocabulary these days, of how people are comparing or evaluating target-date funds, or has that come and gone in the parlance of really differentiating between different processes that target-date managers might have?


Jeff Holt:    That's a great question. You don't see a lot of mention of that in our Landscape Report, and a lot of that is because in the past, as we've looked at two versus through, the reality is, it's an oversimplification of the strategic equity glide path, or just bucketing what that strategic equity glide path looks like, because we found that there could be two series that look very different from one another. One could hold 8% in equities at the target date and one could hold 58% in equities at the target date. Because they're both two, they're lumping them in the same bucket but they're really not similar. And on the flip side, when you look at through target-date series, there could be one that it goes through and it goes through for five years past the target date and there's another one that goes through 30 years past the target date. That one that goes five years is probably a lot more similar to the two approach than the one that goes 30 years past the target date. So I would say that the two versus through, while we still note it and we're aware of it, and plan sponsors and investors should be aware of that approach, two versus through, it certainly is an oversimplification and bucketing the strategy of trying to classify the strategies in a certain type. I would say there are actually two other areas that are similar and that you won't see references to in the Morningstar Landscape Report, would be open versus closed architecture, using the underlying funds. And also, active versus passive target-date funds, just like labeling, it is an active target-date series or is it a passive target-date series. First, on the open and closed, I mean, what we're finding is that there is a lot of series out there that they're usually not 100% one or the other, so there's a mix between the two. It's still important to understand what the mix is between the two but labeling one as open versus labeling one as closed is not as helpful, and so what you'll see in our new target-date series reports for the different series, there is a data point that will actually just show the percentage of how much is in open architecture. So it doesn't bucket it and label a series as being open or closed, but it will just say, "This series has... whether it be 60% open architecture or 20% open architecture, or 0% open architecture." So investors should be aware of what's going on but that classification of open and closed is an oversimplification. And similar with the active, passive, but there really is no such thing as a passive target-date series, but it is important to be aware of what the series is investing in. And what we've found is, at the onset of our discussion, we were talking about how much fees have come down or how much attention there's been to go to low-cost target-date series, and so what we've found is that there's more series that are investing more heavily in index funds. And so, early on, I would say it was more common that you'd see target-date series that were 100% actively managed funds or there were series that were 100% passively managed funds, or in index funds, and then it was very easy to say, "This is a passive series and this is an active series," based on the underlying funds.

Jeff Holt:    But you're finding more firms launch blend series which are intentionally blending to different degrees, active and passive underlying funds, and you're also seeing the legacy active funds dip more into passive funds, so maybe they're an 80% active fund versus 100% a few years ago. We do feel that's very important to know what that percent is and we show that percent in the new series reports and we also highlight the scatter plot showing how the percent in active exposure corresponds to the expense ratio because if a series does invest more in index funds, investors should expect it to be a lower cost. And so those generally are, I would say, are... two versus through, open versus closed, active versus passive, oversimplifications to try to navigate the different target-date series, but I think we've gone beyond those and been able to dig deeper into just really understand what the true differences are between the different series, that we don't need those simple buckets.


Rick Unser:    Yeah. No, I appreciate the extra color there because I was definitely going to ask you for any other oversimplification concepts you think might be out there. One other thing on fees and then we'll move on to some other stuff. One thing I definitely noted in this year's report was, there was a big focus on either the emergence of, or maybe the popularity of, collective investment trusts within the target-date universe, and we've talked about collective investment trusts in the podcast a couple of times, but could you just give me a quick fly over the trees of what a collective investment trust is and then maybe why they are becoming as popular as they are or gaining the amount of assets that they're gaining within the target-date universe?


Jeff Holt:    Yeah. So for a collective investment trust, the way I view it is, it's simply another vehicle to access the same strategy, and so, I mean, it's a different vehicle, so it's under a regulator, it's only available to qualified, institutional investors, so the availability is a bit different than mutual funds. That being said, when we look at strategies, investment strategies, it's often the same portfolio managers running the same strategy but just a different vehicle to access that strategy, and there can be subtle differences and investors should look for those subtle differences if one's slightly different than another, but generally they're often the same. For why they have gotten traction within target-date funds, or why the allure of CITs with target-date funds, really it's to what we've been discussing about that low-cost demand. So the CITs tend to come at a lower cost than mutual funds and so as the investors have been clamoring for low-cost investments, what... We've already touched on one way to lower costs is to invest more heavily index funds. Another way to lower costs is to invest in a different vehicle and like a CIT, and as a result, CITs have grown, and in our Landscape Report, we estimated that, looking at the largest target-date CIT's, we estimate that at the end of 2018, that there was roughly $660 billion in target-date CITs. So you compare that to the approximately $1.1 trillion in target-date mutual funds, I mean, they're a significant component, not quite as large as the target-date mutual funds, but they're growing. And we did see the providers that we examined year over year, we did see a growth in assets which would reflect that in the year that returns are generally negative, that there was strong flow for target-date CITs in 2018. But it makes perfect sense, given that there's so much emphasis on low cost for target-date funds generally, and that this is another vehicle to get to low-cost exposure, that there would be increased interest in the CIT space. Eight of the 10 largest providers of target-date funds offer both the mutual fund and the CITs, so oftentimes the strategy is nearly identical and sometimes there's subtle differences between the strategies. So, as a result, I think that's what's really driving the interest in target-date CITs.

Rick Unser:    And I've had some conversations with folks over the years about the mutual fund versus collective investment trust thing, and I think some people are, "Yeah, I get it. Totally makes sense. Let's do it," and then you have others that are, "Well, you know, I don't know," and I've heard from other people within the market that there is a little, I don't know if skepticism's the right word, but maybe just a little hesitation or reservation about moving out of the mutual fund world into a collective investment trust. I don't know if you get that sense at all or if you've heard any of that or been involved in any conversations like that, but are there any maybe thoughts that you could share with people that say, hey, if you are considering moving away from a mutual fund to a collective investment trust for a target-date fund, here's a couple of things that might make you feel better about that decision, if that's something that makes sense for you and your plan?

Jeff Holt:    At the end of the day, I think it's really up to the preference of the plan sponsor, their investor, on which vehicle they access the strategy. I mean, if the preference is really to be able to go to a site like and type in a ticker or pull a fund perspective out for a mutual fund, I mean, it's ultimately a preference. Target-date CITs, from what I've seen, the availability of portfolio information is... I mean, it's all improved over the time. So it's becoming more similar, in terms of the amount of information you can get for a CIT but, again, it's different, and so I really just view it as two different vehicles and what the preference is, I mean, to the vehicle. And so that being said, I think that should be a decision that plan sponsors consider, whether to go with the CIT or the mutual fund, and that if they do choose to go with the CIT, they should expect as much disclosure or information from the provider and they should expect transparency, and if that makes them comfortable going that route, then I think that's totally fine.


Rick Unser:    And you mentioned a couple of times some subtle differences between mutual funds and CITs. Obviously, we've talked about the cost and how CITs are generally a little more inexpensive than the mutual fund counterpart, but going into the weeds a little bit, are there a couple of things that you guys have noted that are slightly different in the way that CITs are managed versus mutual funds, within target-date series?


Jeff Holt:    Not so much in the way they're managed but sometimes in what is included in the underlying fund. I mean, in some instances we've seen, like in the case of JPMorgan SmartRetirement, for example, and they have a CIT version that includes direct real estate, that's not included in the mutual fund series. Another instance is BlackRock LifePath Index. On CITs, they include commodities. On the mutual funds, they do not include commodities. So, again, subtle differences but differences that an investor should be aware of before going into certain strategies, but, again, in terms of how target-date managers are approaching the strategy, it's largely the same. I mean, it's the same team, usually, and the same overall glide path, and sometimes where the differences tend to lie is sometimes in the underlying exposures to the underlying strategies.


Rick Unser:    That's really good input, so I appreciate you sharing that. I definitely noted in your report this year that there are now multiple firms that have different glide paths or different target-date series that are available. Why is that happening and maybe is that a future trend that becomes more important as this target-date conversation continues to evolve?


Jeff Holt:    Yeah, that's one of the observations we've had over the past several years in our Target-Date Landscape Report. So the number of target-date providers over the last several years, and when I say providers I'm referring to firms that offer target-date funds, and this is mutual funds only, but the number of target-date providers has hovered around 40 or so, over the past several years. But if you look at the number of target-date series out there, it has increased to more than 60 target-date series out there. So initially the number of providers and the number of series would be identical. One provider would come with their best foot forward, saying, "This is the target-date glide, the target-date approach that we want, the glide path, the underlying funds that we want." But what you're seeing now is more of a trend or a willingness for target-date providers to be offering choice, a provider of choice, rather than like, this is the option. And I think what's really driving that is that target-date funds continue to see strong growth year over year, as we mentioned early on. There doesn't seem to be anything that's going to interrupt that trend at this point, or the near future, and so providers want to participate in that growth and you're seeing increasing willingness to adapt to the landscape, to try to participate in that growth. And when I say adapt to the landscape, where the demand is, is what we talked about so far, has been the high demand for low-cost options, and so what you're seeing is, providers increasingly willing to, if they came to market with a series that invested mainly in active funds, that came at a higher cost, we'll recreate a strategy that holds index funds with a similar strategy. And so we've identified, in the mutual fund space, there's 14 firms that offer multiple target-date series and nine of those firms have created a lower cost version of a legacy series and so, in other words, the lower cost version follows the same equity glide path to simply invest more heavily in index funds, whether it be completely in index funds or more of a blend with index funds. Now, the interesting thing is, in those instances, and we highlighted it in our Landscape Report in 2018, is that in all nine cases of the firms that have launched a lower cost series, in all nine cases the lower cost series saw higher net inflows than the legacy one in 2018, and in almost all those instances, the older one was actually in outflows while the lower cost one was seeing inflows. So you can just see that when providers are providing multiple options, the lower cost one is the one that's the most popular with investors, in terms of flows. In terms of assets, sometimes the legacy series still have more assets because they've been around a lot longer, but where you're seeing the flows go is, like I said, is going to the lower cost options. And so it's a bit interesting because, I mean, the whole premise behind target-date funds has been giving options to investors that want to hand over the asset allocation decision to the professionals, and now what you're having is the professionals say, "Well, there's a choice." Not just handing it over, "Here's a choice. You can select this if you want this, this or that." But initially, the premise behind target-date funds was not to necessarily offer choice but to hand it over, to say, "You're a target-date manager, what do you think... how do you think we should invest?" And so that's changed a bit, and that being said, I do understand that glide paths are generally the same, so they have similar beta exposures, but it is interesting to see that there's now several firms that offer multiple target-date series. It's just a trend and it's largely due as they try to adapt to the competitive landscape.


Rick Unser:    And I wanted to drill in on one point you mentioned there. Is it a safe assumption that if a target-date manager offers a lower cost option, and usually they're getting there again through using those passive or index funds, is it safe to assume that that is just a lower cost option and has the same properties as maybe their legacy offering, or is that, as you were pointing to earlier, an oversimplification?


Jeff Holt:    In most cases it should be broadly similar, but it is a bit of an oversimplification because what you tend to see in those instances, when there's a legacy series that invests significantly in active funds, for example, they might have exposures to niche areas of the market, and when they offer the low-cost option, often it's just trying to get exposure to broad asset classes whether it be like, "Here's the U.S. equity market. Here's the U.S. bond. Here's a non-U.S. equity market," and what you could potentially miss are things like high-yield bonds or an area that's included in the sub-ass class glide paths because of a strategy, for an active series, but you're missing exposures in a passive series. So it can result in significant differences. And the interesting this is... One question is is, as these providers have launched the newer, lower cost series, are investors better off if they move to the lower cost series? And so we put together... we examined that in the Landscape Report. We looked at the providers that offer multiple series and we looked at performance from when the newer, lower cost series launched, through the end of 2018, to see how they fared. And in most cases, the lower cost option actually did better, from both an absolute return and a risk adjusted return perspective, and what that would reflect is that maybe those firms' underlying active strategies failed to out-perform or maybe those sub-ass class exposures were detrimental over that time. But, notably, there were instances where the higher cost option, the legacy option, did better, and so investors would have been better off sticking with that one, despite having the higher fees. Talking about the results, I'm talking all about net of fee performance. And, again, it's going to boil down to, do they have some sub-ass classes that are maybe not included in the plain, vanilla index series or has active management been proven beneficial in added value? And so, again, it's one of those things that, as we talked about earlier on, with the emphasis on fees, is that lower costs are not a guarantee, or are far from a guarantee for better results. Oftentimes, if the active management is not delivering, they can post better results, but, again, it's not a guarantee.


Rick Unser:    As you look out into the marketplace, or as you're having conversations with other managers, as you're putting the report together, or just whenever, what else are you seeing that managers are thinking about or contemplating, either about the design of the current funds or as they gaze into the future and say, "Hey, here's some things that we're trying to solve for within the target-date design glide path, make-up, et cetera"? What are you seeing or what are you hearing people think about or talk about or try to solve for?

Jeff Holt:    That's a great question, and it really depends on the provider. I mean, through our discussions, as we cover target-date series, and issue analyst ratings for those series, we're in constant communication with different portfolio managers, and it's apparent that there's some series that the portfolio managers are very content with the design that they've set up for maybe several years ago and they expect to stay the course going forward. And there's also cases where you can see there's tinkering around, I would consider it tinkering, where there's moving funds here and there, maybe small changes here and there, but generally the strategy's staying somewhat similar. But then there are also the managers for series that are proactively trying to innovate or evolve in the space, and I would say one of the areas that has been a hot topic for several years has been retirement income, what to do in the retirement phase. And it's been a tough nut to crack and several providers have tried creating target-date funds, whether it be including an annuity feature or a guarantee minimum withdrawal benefit, or some sort of aspect that incorporates some sort of guaranteed income. That continues to be on top of mind of the providers that are seeking to evolve or innovate in the space. We've seen over the last few years a few larger providers in the space, like [T.R. 00:34:30] Price, JPMorgan, and Fidelity have revisited or launched managed payout funds that often have a similar construct to a target-date fund but have more of a design to help investors with the taking payments from their target-date fund, and we've seen other providers that have also come up with different type of tools or solutions or tie-ins to their target-date funds that are trying to address that retirement income need. That being said, nothing has really, really gained significant traction in that space. So it's still one of those strategies, hoping to solve the issue, or help with the issue, but, in terms of traction or really building it into a target-date fund, we haven't really seen it done at this point. And so if you look at the largest target-date series, and it's a very top-heavy marketplace, in terms of the providers of target-date funds, you're not seeing their flagship target-date series have a large component or some sort of feature on the retirement income at this point, but I think it's still an area of the next frontier for target-date funds.

Rick Unser:    Yeah, and, I mean, I think I've heard some people say, "Hey, this is target-date 2.0." And so, if I'm hearing you right, I think that's still a little ways away, in terms of truly getting to a 2.0 versus maybe a 1.2 or 1.6 iteration on a current theme.


Jeff Holt:    And the hard thing is to know what would be the driver or the tipping point that would make that change, what would make it a 2.0 rather than just a 1.2. I mean, we've seen the [Secure Act 00:36:19] with the proposal, making it a [inaudible 00:36:22] available for target-date funds to include annuities, whether it's going to be a large provider or plan sponsor that steps out and does it and then others follow suit, but we've seen some of those things [inaudible 00:36:37] and encouragement but it's still been an area that providers have been reluctant or hesitant to follow, and so I think it will be interesting. It will be interesting to see what happens in the next five years on that front, whether there will be a solution. And, frankly, it is a harder area to solve for because target-date investors, early on in their careers, they're in a similar boat. They need to invest and they need to save and invest in a diverse portfolio and just build a balance. Where situations begin to differ significantly is as they get to retirement, or where individuals will have very different family circumstances, health circumstances, that will influence how they want to trod down their income, and so that complicates it. So I don't know that it's going to be an easy solution out there or if it's going to be using a variety of different solutions that providers are trying to create. So it will be interesting to see how that evolves in the next few years, but we are seeing target-date managers look at that space.

Rick Unser:    And one other thing you mentioned a minute ago was an observation I had from your report as well, which it seems like the 80 / 20 rule is alive and well within the target-date universe. Maybe share a couple of thoughts on that, and then, is that a good thing, does that help or does that maybe hurt anything going on in terms of trends or innovation, competition within the target-date landscape?

Jeff Holt:    Well, certainly with target-date funds you've seen that it's top-heavy, in terms of the competitive landscape, and it's continuing to be top-heavy, a few providers dominating the landscape. And I think your question is whether that's helping or hurting the competitive landscape. The good thing for the target-date landscape is that providers continue to see that it grows, so you're seeing even providers who have exited re-enter, or trying to make attempts to penetrate that space or participate in that growth. Those providers can't become totally complacent but being that the assets have grown to so much for some of those larger providers, it's hard to see a provider that's seeing significant flows in growth to their assets willing to take significant risk with new features and new design to their target-date series, whether it's to address retirement income or other aspects, when things are going well. So I think there will continue to be competition in the space but it's a hard area. I mean, without a doubt, it's a hard area, and that's why we've seen providers... every year we see two or three providers liquidate and I think largely it comes to the point where it's like they've been around for years and they're just not seeing... they haven't been able to attract attention. And I do think the landscape's shifted as to who's dominating and why they're dominating, who the largest providers are in the space. Initially, early on, we referred to them in the past as the big three, would be Fidelity, Vanguard and T. Rowe Price were the largest providers, and oftentimes, it was, as target-date funds really took off in the mid 2000s, those were providers that had record-keeping businesses, and so, early on, it was fairly common that a plan sponsor would use a record-keeper and use the same target-date series that was offered by the record-keeper. So you saw series from those three providers really take off and dominate the market. As there has been more emphasis that those are two distinct decisions and that there should be open architecture with the record-keeping platform, and the investment for a plan, you've seen what has actually dominated more than the record-keeper decision has been the cost decision, and as we've described to this point. So if you look at that context, what you're seeing is, the big winner, in terms of asset or growth over both those areas, has been Vanguard. I mean, Vanguard was a record-keeper in the space early on launch target-date funds, whereas Fidelity, with Fidelity Freedom, and T. Rowe Price Retirement, they have invested in series that were a little... they had higher costs because they invested in actively managed underlying funds, and so early on, those were the big three. And then what you're seeing as the shift has been to the demand for low-cost providers, you're seeing Vanguard's really taking the lead and is attracting a lot more flows, as they've been a low-cost provider in that space for a long time. But then you're seeing other low-cost options gain assets. You've seen BlackRock LifePath Index, particularly on the CIT side, gain significant assets. And you've seen American Funds, which does invest in active strategies, but tends to come at a lower cost than some of its peers, again, back to that cost aspect, and they've significant inflows over the last few years. And so you're seeing some changing of position of that top-heavy space, of those providers, but the other thing to point out is that, of, and I mentioned earlier, roughly 40 providers in the space, there's 17 providers that have less than $1 billion in target-date mutual fund assets, and some of those have been in the market for over 10 years and just haven't been able to build up significant traction. So, again, it's top-heavy and the tail's gotten, I would say, even smaller, but there is still going to be jockeying for position among those top providers. And right now, it seems like the big driver has been price and, I guess, the question will be is, what will be the next big driver on what really determines who's going to attract most of the flows.


Rick Unser:    Yeah, no, well said, and maybe, I don't know, if this becomes a driver, but certainly one thing that was very evident in 2018 was performance, and we had a pretty big shock in the fourth quarter. I think the good news is, at least my observation, we didn't have quite the same, I don't know if press coverage is the right word, but certainly there was a lot of very negative things said about target-date funds in the 2008 financial crisis. I don't know if some of that was more geared towards people not really understanding what target-date funds are or how they work, but I feel like, as we had 2018, and certainly the fourth quarter of 2018, which had a pretty big move on the downward side, I feel like maybe people took that a little bit more in stride. So I don't know if that's better understanding, better appreciation for what a target-date fund is, or if it was maybe target-date funds are doing a little better job of managing risk and downside.


Jeff Holt:    So, 2018 wasn't as rough as 2008.


Rick Unser:    Absolutely.


Jeff Holt:    So on average, we looked at target-date funds, they were down roughly 6% in 2018 compared down to 37% or 30%ish in 2008. But hopefully investors and plan sponsors and just everyone in general, as target-date funds have been around for longer, have a better understanding of what they deliver, which is a diverse [inaudible 00:44:02] portfolio and not like a guaranteed return or a guaranteed income amount. So, yeah, 2018 wasn't as difficult, but the reality is...So sometimes I get the question of, are they doing something different now than they did back in 2008? And by and large I'd say, if providers have changed their equity glide path or their exposures, more often they've increased equity exposure since 2008 than have decreased their exposure. So if the 2008 scenario happened now, in terms of the size of the draw down, investors should expect target-date funds to participate to probably the same extent or maybe even more than they did in 2008. Again, they're still just providing market exposure. And so hopefully 2008 is not going to be a frequently recurring event but certainly in 2018, was the case, you will see dips, and target-date funds are going to participate because target-date funds provide a diverse [inaudible 00:45:05] portfolio but in 2008, where the only place to go was cash, target-date funds aren't meant to do that, and most target-date funds, the managers aren't going to try to time that, in terms of moving 100% of the portfolio to cash in anticipation of a huge draw down. And so investors should expect to participate in the market, but it should be diversified and that's really what the target-date funds deliver. The one benefit too is though, and what some target-date managers have decided is helping them be comfortable with raising their equity exposure at certain parts of their glide path, particularly investors earlier in their career, is that they're finding that, looking at the data, that the target-date investors are pretty stable. I mean, they're not moving in and out based on the market trends, which shouldn't come really as a surprise because target-date funds are meant for the investors that want to hand that off to professionals. So when the markets go awry or are really volatile, it's hard to understand why an investor would immediately think that they could do it better than the professional, at that point of stress, and so what they're finding is that most investors are staying the course, which is good, for an investment strategy. It avoids the potential of buying high and selling low, the bad behavior that we see sometimes from investors. So the good thing is, target-date funds are pretty sticky and they're steady with their investments and so, again, the target-date funds, they'll try to diversify their portfolio but they can participate in draw downs.

Rick Unser:    Yeah. And I guess on that note around changing conditions and managers, one thing that we've talked about a couple of times on the podcast is that the go forward return expectations for the market are a little more subdued than maybe what we've seen over the last decade, since we've emerged from the financial crisis. Are managers mostly staying the course with their broader strategic glide path design or are you seeing people talk about making some changes as a result of maybe some different capital market assumptions? And maybe a little bit of a different spin here, does this maybe set up well, potentially, for someone who has a little bit more of a dynamic approach to their glide path versus something that's a little bit more static, if we do see some of these more challenging market conditions emerge over the next five to 10 years?

Jeff Holt:    Yeah. I would say generally in our conversation with the target-date managers, there is the expectation that generally returns are going to be a bit more muted than they have historically. Whether that's changing how they're designing their glide path really varies, strategy by strategy. So we have seen some firms that have revisited their capital market assumptions and they're adjusting accordingly, maybe strategically, maybe tactically. I guess one of them that's just an overall trend is, we have seen is, particularly as the U.S. market's been done... so U.S. equity market's done so well for the last several years, you're seeing that trend of exposure to non-U.S. stocks increase, and you're also seeing exposure to non-U.S. bonds increase. And so you're seeing generally a more moving away from such a pronounced home country bias within, and I think the fact that the U.S. equity market's been such a good place to be over the last several years, that the timing feels right for some of those managers to make that change. And the expectation is, I mean, again, it varies case to case. So there are some series that are, it's set the way it is and it's going to stay the way it is. Other series are either constantly revisiting their capital market assumptions and they're revisiting. But in terms of the dynamic or static, whether this market environment is presenting an opportunity, I would say it maybe would on the margin, but even when managers are dynamically allocating or making tactical adjustments based on the market opportunity, oftentimes it's within fairly tight constraints or they have tracking error budgets to stay within or they only have certain limits of how far they can deviate from the strategic glide path or within the sub-asset classes, and so they're usually not like... they might get a little bit of benefit if they make the right calls in those space, but I'm not expecting to see a huge windfall based on a tactical move. So I would say, generally, the glide paths, they may be changing a little because of the market environment, but we're not seeing dramatic changes, by and large, by providers.

Rick Unser:    No. Perfect. All right. You've shared a ton of great info. Is there anything we haven't talked about that you would have hoped I'd asked you about relating to target-date funds or your report, or are there a couple of parting thoughts that you'd want to send people away with to tie some of this together?

Jeff Holt:    The only thing I could bring up... I mean, we didn't touch fully on, was the importance of looking at, when evaluating the target-date landscape, how important it is to look at both the CITs and the mutual funds, and it's important because CITs have grown, and as I've mentioned, they're still not quite the same size as the target-date mutual funds, but they have grown, but if a planned sponsor or investor looks at just one or the other, they might not get the full picture, in terms of assets or flows. And so an example of looking at assets, I mean, if you just look at target-date mutual funds, you get a view of who are the largest providers, but when you combine the CITs, you'll see the view that BlackRock and State Street both manage significantly more in target-date CITs than they do mutual funds so they're a much larger provider in the space. So you get that kind of insight. The same goes with the flows. If an investor just looked at the flows for T. Rowe Price and Fidelity for their target-date mutual funds, they would have seen outflows and they may prematurely come to the conclusion of T. Rowe and Fidelity are bleeding assets or losing assets in the space, and assets are exiting their mutual funds but both those firms, in this case, are inflows to their CITs that more than offset the outflows. So on a net basis, and we have an exhibit in our Landscape Report, that shows that you see that, and on that basis, they are in positive flows, from a target-date strategy. So, again, the landscape for target-date funds has evolved to a point where it's really necessary to get a complete view, to consider both the mutual funds and the CITs. In terms of your question on parting thoughts, on the wrapping it all together for target-dates, and I go back to what we were talking about earlier on, is like how... it's very apparent that price is such a big factor in the growth of a target-date fund, that we're seeing the lower cost funds just gather all the inflows, but how important it is for plan sponsors and investors to really consider the other aspects behind the target-date funds, to consider the team that's managing the series and to be really confident in the team, and to really understand the strategic equity glide path, but also the sub-ass class glide path, to really illuminate what's going on with the series, to really understand what's going on with their approach.

Jeff Holt:    In our new target-date fund series reports we have revised our attribution methodology to help investors to get a sense of how much allocation decisions versus the performance of the underlying exposures is driving performance, and, again, it's all with the goal to understand performance [inaudible 00:52:55], set expectations for performance going forward. So if a plan sponsor advisors or investors have that expectation and they have the right information then to make those... set those expectations appropriately, they can be that much more confident in their selection of a target-date series.

Rick Unser:    Very well said. I appreciate everything you've shared today, and as you know at this point, I'll come knocking again next year, and would love to have you back at that point to chat about any additional observations you have about the target-date universe.


Jeff Holt:    Yeah. Excited to see how the target-date fund landscape continues to evolve. So it's going to continue to see growth and with that growth I expect there to be evolution.


Rick Unser:    We like evolution. Thanks again, Jeff, and until next time, we will look forward to chatting.


Jeff Holt:    My pleasure. Thanks, Rick.

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