The ‘Smart’ Ingredient in Next-Gen Target Date Funds

It could reduce volatility and sequencing risk for retirement investors when markets decline

401k, retirement, target date fundsInnovation with the product continues.

Love ‘em or hate ‘em, target date funds are all the rage, and “smart beta,” an increasingly popular investment strategy, will be key going forward.

New research from global research and consulting firm Cerulli Associates finds that 38 percent of asset managers predict that use of smart beta strategies, often referred to as strategic beta, is the most likely feature of next-generation target date products.

Smart beta strategies, which seek to deliver better risk-adjusted returns relative to traditional market-cap-weighted allocations, include elements of both passive and active investing. They’re active in their objective of outperforming broad market indices, but also passive in their systematic and rules-based implementation.

Conversely, target date funds are long-term investment products, meant to be held throughout multiple market cycles, the Boston-based company adds.

Asset managers incorporating smart beta into their target date series could find success by positioning their products as cost-effective strategies capable of reducing volatility and sequencing risk for retirement investors when markets decline.

“In a target date market dominated by low-cost, passive providers, strategic beta strategies are a way for active managers to compete with pure passive on cost while retaining some of the value-add tenets associated with active management,” Dan Cook, an analyst at Cerulli, said in a statement. “For the larger target date providers, strategic beta series can also serve as another option in their target date product suite, giving plan sponsors the choice between passive, active, and strategic beta.”

While advancements in target-date product development, such as strategic beta or hybrid offerings, have the potential to improve participant outcomes, they will likely add another layer of complexity to the due diligence process at the plan level, Cerulli says.

“For this reason, asset managers entering the defined contribution market with new target date products must clearly explain the benefits of these products and provide plan fiduciaries with all relevant details necessary to support thorough due diligence.”

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