Morningstar Magazine - June/July 2018 - 56

Spotlight: Packaged Investing

at the end of 2017, a 5-basis-point decline from
0.71% the previous year. The average assetweighted expense ratio has come down by more
than 35% since hitting 1.03% at the end of 2009.
The declining asset-weighted expense ratio comes
from a variety of sources: existing target-date
providers lowering their fees, investors selecting
lower-cost share classes, the liquidation
of pricey target-date series, and the arrival of
competitively priced series. A review of
how each series' asset-weighted expense ratio
changed over the past year helps identify the
source of the decline.
Most target-date series' asset-weighted expense
ratios declined in 2017. The Voya Index Solution
saw the biggest drop of 28 basis points. Voya
reduced the underlying fund fee and increased net
flows to its lowest-cost share class, the
Z shares. The Prudential Day One series, which
launched in December 2016, saw its assetweighted expense ratio come down significantly
in 2017, as the majority of flows went to
its lowest-cost R6 share class. Meanwhile, the
notable declines for the Wells Fargo Target and
Schwab Target series both came from cutting costs
in 2017. Wells Fargo's fees declined after
it revamped the series in mid-2017, while Schwab
injected more passively managed strategies
into the underlying mix, which lowered fees.
While target-date funds' average asset-weighted
expense ratio has declined to a historical
low, most investors in the funds actually pay less
than the average. Unlike the average assetweighted expense ratio, which weighs each series
equally in calculating the average, the marketshare-weighted expense ratio considers
each series' market share. The 0.47% marketshare-weighted expense ratio at the end of 2017
came in well below the 0.66% asset-weighted
average expense ratio, reflecting that lower-cost
offerings are winning investor assets.
Buyer Beware

Low costs allow investors to reap more of their
investment gains, but investors in targetdate funds need to look beyond price tags to
investment strategy to determine the
appropriateness of the fees. A target-date

56

Morningstar June/July 2018

The distinction between "active" and "passive"
target-date series has become more muddled in
recent years. Several target-date series that
have historically held actively managed strategies
have inserted or relied more heavily on
passive funds. Meanwhile, other series explicitly
aim to blend active and passive funds.

The series holds individual securities that together
replicate indexes in certain asset classes.
Elsewhere, the Dimensional Target Date
Retirement Income series is classified as holding
more than 80% of assets in active strategies
with an expense ratio of just 0.24%, but the firm
keeps costs low through an overarching
systematic, rules-based approach that's distinct
from traditional active management. American
Funds Target Date Retirement (0.39%), TIAA-CREF
Lifecycle (0.42%), Fidelity Freedom (0.45%),
JPMorgan SmartRetirement (0.48%), MFS Lifetime
(0.49%), and American Century One Choice
(0.5%) all come in notably lower than the 0.55%
average for a series with 100% in active strategies.

Some target-date series may appear competitively
priced on the surface, but less so when
considering their passive exposure. The GreatWest Lifetime and Lifetime Conservative series
both have expense ratios that would be
close to the norm for a 100% active strategy, but
those series hold less than 60% in active strategies.
Similarly, the Schwab Target series' 0.58%
expense ratio looks less appealing given it held
only 68% in active strategies at the end of
2017. Meanwhile, the Principal LifeTime Hybrid
series launched in 2014 as a low-cost alternative
to the firm's legacy series, but its 0.43% expense
ratio looks ordinary rather than a bargain
considering roughly two thirds of the assets were
in passive strategies at year-end 2017.

Target-date funds hit a momentous mark in 2017
by eclipsing $1 trillion in assets. It's clear
that target-date funds play an important role in
the retirement success of more and more investors.
As investors flood into target-date funds, their
overwhelming preference is for series that own
passively managed funds. This preference is driven
by a growing demand for low-cost investments.
Fees for target-date funds continue to fall.
The injection of more passive exposure within
active target-date series and the launches of series
that blend active and passive funds have
fueled the trend. We anticipate that target-date
providers will continue to adapt to meet the
burgeoning demand for low-cost, passive options. K

provider's decision to use actively or passively
managed strategies to gain exposure to
desired asset classes directly affects a target-date
series' cost. Investors in series that hold passive
strategies should generally expect to pay
less, whereas active management often comes
with a higher cost.

Not all passive series come with low costs. The
passive series with low expense ratios includes the
Schwab Target Index (0.08%), Vanguard
Target Retirement (0.09%), Fidelity Freedom Index
(0.1%), TIAA Lifecycle Index (0.1%), BlackRock
LifePath Index (0.12%), and State Street Target
Retirement (0.13%). Still, four passive series have
expense ratios above 0.5%: ClearTrack
(0.55%), 1290 Retirement (0.65%), Great-West
SecureFoundation Lifetime (0.68%), and State
Farm LifePath (0.72%).
Some target-date series that are not among the
cheapest available are attractively priced
when their investment in actively managed funds
is considered. While the Wells Fargo Target
series stands out with its 0.2% expense ratio while
being 100% active, its exposure includes passive:

$1 Trillion and Counting...

Jeff Holt, CFA, is director of multi-asset and alternative
strategies with Morningstar Research Services.
Heather Larsen is a manager research analyst with
Morningstar Research Services.



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