Passive strategies have largely dominated target date funds for the past few years.
In 2017, passive TDFs captured an eye-popping 95% of net TDF flows, according to Morningstar Target Date Research.
However, new research from PGIM Investments looks at why a shift to hybrid TDF strategies may be on the horizon. Hybrid TDFs, which combine active and passive management, emulate a more institutional approach to managing multi-asset class portfolios.
Passive exposures help keep participant expenses low, while active exposures provide participants the potential for added incremental returns and the mitigation of key investment risks, according to the report.
One reason hybrid approaches may be on the rise now is that active exposures can help mitigate market declines and interest rate volatility
“Market environments change and the performance tailwinds for passive investments are unlikely to persist indefinitely,” the report states. “In fact, as interest rates rise and market volatility returns, more asset classes have edged closer to (if not actually entered) bear market territory.”
Because of this, active management, in both equities and fixed income, may be poised for a period of outperformance, according to the report.
Compared to active TDFs, though, hybrid TDFs are normally less expensive to participants. According to the report, hybrid TDFs also – depending on the level of participant investment – often reduce overall participant costs for the entire plan.
The average expense for an active TDF was 0.91%, compared to 0.76% for a hybrid TDF or 0.54% for a passive TDF, according to Morningstar data from 2018.
The report does evidence that hybrid TDFs are capturing a growing share of outflows from active TDFs.
Morningstar data shows that net flows into hybrid TDFs have increased by over 400% in the past three years, doubling the amount of assets in the category.
The number of hybrid TDFs available in the marketplace has also grown, from only nine hybrid TDFs in 2009 to 16 at the close of 2017.
Some of these are from new providers, but several others are from existing TDF providers that have introduced hybrid versions of their active flagship TDF products.
“Following the lead of managers of institutional pools of capital (such as insurance company separate accounts, defined benefit plans, and endowment and foundation portfolios), there is growing awareness among defined contribution plan sponsors and fiduciaries that an institutional approach—one that thoughtfully incorporates both active and passive exposures—can increase the probability of successful outcomes for plan participants,” the report notes.
The report notes that there is a large disparity between the active and passive exposures among hybrid TDF providers. Because of this, a meaningful evaluation of hybrid TDF expenses needs to be made within the context of the series’ active (or passive) exposure.
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