August 10, 2011

Sponsors Limit Target Date Fund Picks: FRC Study

Target-date trend comes as Morningstar downgrades Schwab fund family

Although an entire series of target date funds may be marketed to retirement plan sponsors, they may decide to choose only a few funds out of the series. So say data from a new analysis of 401(k) recordkeeper platforms released Tuesday by the Financial Research Corporation (FRC).

FRC LogoThe FRC study was released at the same time that Morningstar completed its quarterly review of target-date fund family ratings, and some changes were made—including a downgrade for powerhouse target-date provider Charles Schwab.

Morningstar, in its quarterly review of target-date fund family ratings, downgraded Schwab to Below Average from Average because of the sudden departure of its previous manager “and the lack of clear, long-term succession plan.” While an interim manager from Schwab’s collective trust group has been named, Morningstar said, “there is currently a great deal of uncertainty about what this series will look like in the future.”

The FRC study, "Trends in Target-Date Portfolios on Recordkeeper Platforms,” is a joint project with BrightScope, a provider of retirement plan ratings, and the authors say the study reveals a trend that may mean trouble for fund managers. Because not all funds in a series are accepted by sponsors, they say, some fund managers may be confronted with unanticipated demand for their funds.

According to the data, fund selection differs by recordkeeping platform and by retirement plan, an indication that sponsors likely are choosing only those funds that suit the specific demographics of their participants. While such customization can be good for a plan, it can spell trouble for a larger target-date fund series.

The report is one of the first to look at adoption of target-date series funds on 401(k) platforms. In addition to the possible trend cited above, it examines the way recordkeepers and sponsors use target date products, and looks at product distribution trends.

“Target date funds have experienced explosive growth in recent years and continue to be a notable bright spot for the mutual fund industry,” said Mike Alfred, CEO and cofounder of BrightScope, in a statement. “Asset managers who wish to move the needle in this space must have a holistic view into the marketplace dynamics so they can capitalize on the significant distribution opportunities.”

Lynette DeWitt, author of the report, pointed to BrightScope data revealing that in one retirement plan, only five out of 12 funds in a target-date series were selected by the plan sponsor. When this trend plays out in the broader marketplace, DeWitt said, it can lead to varying asset levels across target-date categories. As seen in FRC’s data, she added, 70% of target-date mutual fund assets are held in the five most popular fund categories: 2015, 2020, 2030, 2025 and 2040.

“We’ve known already that a few fund categories hold the largest assets, and now we understand why,” DeWitt said. “We anticipate that the less popular funds in a series will remain open to maturity now, but target-date series in the future will be comprised of fewer funds.”

In other target-date news from Morningstar, DWS also suffered a downgrade, from Below Average to Bottom because of continued underlying fund performance deterioration and also a decline in its People score due to management turnover in many of its funds.

Also, Morningstar said that BlackRock and State Farm LifePath switched strategies from enhanced index to active management, and ING gave up a “stepped” glide path for “a more conventional curved glide path.”

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