In Target-date fund providers struggle to compete, Pensions & Investments reports:
“More fund closings, fewer launches as five giant firms maintain grip on market. The target-date fund market is becoming saturated, causing providers to liquidate… in an industry dominated by five companies with nearly 80% of the market share.”
The $3.5 trillion target date fund (TDF) industry is an oligopoly. Non-oligarchs are tired of scrambling for crumbs. That’s simply Darwinian survival of the fittest, but what if the oligarchs (“whales” in Las Vegas jargon) are not the fittest, and could (should?) be harpooned?
In this article I explain how the oligopoly formed and why it wasn’t due to superior product, and then I discuss what I do consider to be superior product and why it is changing the game. Personalized target date accounts done right are the future of 401(k) plan investing.
The birth of the TDF oligopoly
It all began with the Pension Protection Act of 2006 that declared TDFs to be Qualified Default Investment Alternatives (QDIAs). It didn’t take long for fund companies to figure out that they could profit by filling up TDF glidepaths with their proprietary funds—they packaged product into TDFs. And they designed glidepaths to maximize profits.
Consultants didn’t look far away from home in choosing TDFs. They chose their clients’ bundled service providers. No one questioned the fact that the theory fund companies say they use is not actually being followed because—hey—“those guys are really smart.”
Convenience and familiarity launched the oligopoly. “They’re all alike, so choose someone you know” is the thinking. Everyone has marketing that dazzles with persuasive simulations run by Ph.Ds that “prove” that their design replaces pay and manages longevity risk.
Then once a few bundled service providers dominated, procedural prudence—and fear—generated snowballing because no one would dare to try something new or different. This is a litigious society after all. But in the case of TDFs, substantive prudence is not the same as procedural prudence, and therein lies the door opener for newbies.
The oligopoly prospers because no one has questioned glidepaths nor considered better alternatives until recently. The biggest shortcoming of TDFs is their one-size-fits-all limitation, so newbies have entered the market with personalized approaches that improve not only on TDFs but also on managed accounts, the second most popular QDIA.
Personalization
Investing is personal, so one-size-fits-all simply won’t do Interest in managed accounts has recently intensified, but we can and should do even better by blending managed accounts with TDFs to create personalized target date accounts (PTDAs).
PTDAs have been around for a while, but most make the mistake of trying to serve people who do not want to engage, namely defaulted participants, by using recordkeeper data. A recent PIMCO survey confirms that this data doesn’t tell us much in most cases. We can only know the net worth of lifers who are invested entirely in the 401(k).
As a practical matter we can only provide personalization to those who want to engage, as do self-directed participants. Self-directed participants hold about a $trillion of the $3.5 trillion in TDFs. We personalize investments by letting participants navigate their own unique target date accounts through time based on fluctuating risk decisions as life brings its usual ups and downs. This is not a QDIA because it’s not for defaulted participants.
PTDAs also serve as QDIAs without using recordkeeper data by giving plan sponsors lots of flexibility. Sponsors choose a glidepath with risk that is appropriate for the workforce and specify a retirement date, like age 65. The PTDA “sees” the retirement date as the day of retirement rather than grouping into 5-year or 10-year cohorts. Sponsors “build” their QDIA in accordance with DOL guidelines.
Smart personalization does not try to personalize for defaulted participants by using recordkeeper data. Only a couple PTDAs hand the reins over to self-directed participants but not defaulted participants. I view these as smart PTDAs.
Most importantly, smart PTDAs manage Sequence of Return Risk, unlike most TDFs.
Advisors benefit from personalization because investors benefit
Morningstar recently released a study titled, Four Opportunities to Elevate the Advisor-Client Relationship through Personalization, in which it discusses:
• How important is personalization to investors?
• What do investors mean when they ask for personalization?
• How are advisors’ practices evolving in response?
Investors want personalization because investing is personal. That’s the “Voice of Client.”
Conclusion
Buddha said, “Impermanence is eternal.” The TDF world is evolving for the better. Keep watching.
It will take a market crash to expedite the evolution because then we’ll see who is swimming naked (with high risk). It’s not “if,” it’s “when.” All is well, until it’s not.
Ron Surz is CEO of Target Date Solutions (TDS), co-host of the Baby Boomer Investing Show (BBIS), and author of the book "Baby Boomer Investing in the Perilous Decade of the 2020s." TDS licenses target-date fund usage of Ron’s patented Safe Landing Glide Path® (SLGP) that actually protects beneficiaries as they approach retirement. Individual investors can follow the SLGP at Age Sage, an educational interactive website. The BBIS educates baby boomers on the risks and rewards in contemporary investing, and Ron’s book is a tour of these shows. He can be reached at Ron@TargetDateSolutions.com.
