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Portfolio > Mutual Funds

Custom TDFs Will Surge to $218B by ’16: Cerulli

By Janet Levaux

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Cerulli Associates projects that custom target-date strategies will account for 22% of 401(k) target-date assets by 2016, the consulting group said Friday in “The Cerulli Report: State of Large and Mega Defined Contribution Plans: Investment Innovation and the Plan Sponsor Perspective.” This would put the amount of custom target-date fund assets in defined contribution plans at $218 billion, up 370% from the $46.4 billion posted in 2011.

Given that target-date funds had overall second-quarter returns of 2.8% and 12-month returns of -0.5%, according to the research group Ibbotson Associates, investors may be looking for custom target-date funds as a way to improve returns.

Custom target-date funds can include alternative structures—such as collective trust funds over mutual funds, for instance —though mutual funds are expected to remain the product of choice for the majority of choices in plan investment lineups, according to Cerulli. Cerulli’s research also notes that custom target-date funds “open the door for alternatives in DC plans,” since alternative asset classes have typically not been included in DC plan portfolios.

“We believe that plans will add custom target-dates at a rate of 2% per year for the next two years,” says Kevin Chisholm, a Cerulli senior analyst and lead author of the study, in a press release. “The use of custom target-date funds provides access for DCIO asset managers to the growing pool of DC assets.

Cerulli’s research also observes that custom target-date funds “open the door for alternatives in DC plans” as alternative asset classes have typically not been included in DC plan portfolios.

The Cerulli report notes that plans with more than $1 billion in assets are more likely to use custom target-date strategies than plans with less than $1 billion. Cerulli estimates that target date assets in the mega market segment now total $139.5 billion.

“In addition, these products also allow new asset managers to participate in the market, outside of the few that have dominated the space since the Pension Protection Act of 2006 blessed these funds as Qualified Default Investment Alternatives,” Chisholm explained.

Performance Push

The second quarter wasn’t kind to the markets or target-date funds, according to Ibbotson Associates. However, both equity and fixed-income markets had decent 12-month performance results, based on June 30 data, though target-date funds have not kept pace, says the research group, which is part of Morningstar.

“Non-U.S. equity was the biggest drag on target-maturity performance” in the March-to-June period, according to Jeremy Stempien and Cindy Galiano, both directors of investments for the organization and authors of a second-quarter update on target-date funds released in late July.

In the first quarter of 2012, target-date funds had average returns of 9%. But during the second quarter, Ibbotson reports, the average loss for target-maturity funds was 2.8%, nearly identical to the performance of the S&P 500 Index and almost 5 percentage points lower than the Barclays U.S. Aggregate Bond Index. “The poor performance was driven by the dismal performance of non-U.S. equities, which lost almost 7%,” the authors explain.

Plus, the 12-month performance dropped into negative territory, with the average target maturity fund losing 0.5%. Again, this was “driven by the underperformance of non-U.S. equities,” which lost more than 13% over the period. Over the past 12 months, the S&P 500 improved 5.5% and the Barclays U.S. Aggregate Bond Index ticked up 7.5%.

Still, assets kept moving into target-date funds, which benefit from auto-enrollment and auto-escalation features associated with many corporate and other retirement plans. As of June 30, assets in target-maturity funds totaled $431 billion. The “big three,” Fidelity, Vanguard and T. Rowe Price, continue to garner most flows, and captured close to 75% of net flows during the second quarter.

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