CITs capturing mutual fund TDF assets
This year’s Morningstar Landscape report offers insights into TDFs packaged and offered as collective investment trusts.
Assets in target-date mutual funds declined last year for the first time since 2008, as strong net new flows were not enough to offset a down year for equities.
Mutual fund TDFs held $1.09 trillion at the end of last year, down from $1.11 trillion at the end of 2017, according to Morningstar’s recently released Target Date Fund Landscape report.
The $55 billion of new flows in 2018 was down from 2017’s record flows of $70 billion to TDF mutual funds, but still healthy. The vast majority went to lower cost funds passed on indexed strategies.
Equity markets were a headwind for TDFs in 2018, as the S&P 500 index declined 4.38 percent for the year.
TDFs lost 6.22 percent in value, on average, over the year, with those vintages furthest from retirement that hold the greatest equity exposure losing the most. The average 2060 vintage lost 8.52 percent in value, compared to at-retirement vintages that lost an average of 3.16 percent.
Funds with expense ratios of 20 basis points or less saw $57 billion in new flows, while funds priced at 60 basis points or more saw $37 billion leave.
“Price is driving the popularity of TDFs,” said Jeff Holt, director, and lead author of Morningstar’s annual Landscape report. “The demand for lower cost investments continues.”
Here come the CITs
This year’s Landscape report includes an expanded look into TDFs packaged and offered as collective investment trusts. CITs can only be offered to institutional investors and are operated by bank or trust companies. Unlike mutual fund TDFs, CITs are not regulated by the Securities and Exchange Commission.
CIT TDFs can be offered at a lower cost than a mutual fund with identical sub-investments and glide paths, in part because they have fewer reporting requirements. Fees on CITs are sometimes negotiable.
Defined contribution plans now hold $660 billion in TDF collective trusts, putting the value of the total TDF universe—mutual funds and CITs—at $1.7 trillion.
According to Holt, eight of the top 10 TDF providers now offer a version in CIT form, another consequence of plan sponsors’ and retirement investors’ demand for lower cost options.
As flows to mutual funds dropped by $15 billion year-over-year, total assets in CITs increased by $30 billion in a year of negative returns.
Morningstar doesn’t track year-over-year flows to CITs, but Holt said CIT’s resilience in down markets presents strong evidence that CITs are cannibalizing assets in TDF mutual funds.
CIT’s growth also suggests they are being offered beyond the mega-plan market, the traditional domain of collective trusts.
Research from Cerulli Associates shows trust managers are lowering minimum investment requirements, and in some cases dropping them altogether, giving mid-sized and even small plans access to the cheaper vehicles.
Nearly three-quarters of TDF sponsors now offer a CIT version of TDF mutual funds, according to Cerulli. And 26 percent of those lines do not have a minimum investment requirement.
When managers do impose a minimum investment requirement, some base it on total plan assets, and others base it on assets in TDFs. Minimums range from $1 million to $250 million.
Morningstar’s Landscape report doesn’t break out CIT offerings by plan size, but Holt says it is completely conceivable that collective trusts’ asset growth is in part powered by wider offering across the plan size spectrum.
“CITs must be becoming more accessible to more investors, given their growth,” said Holt. “Providers want to knock down hurdles to participate in that growth. It would not be at all surprising if TDF CITs are becoming more accessible down market.”
Vanguard reported $28.4 billion flows to CIT TDFs last year, compared to 40.7 billion in flows to its mutual fund series. The firms total CIT assets are nearly $253 billion, compared to $396 billion in its mutual fund TDFs. Total TDF assets are over $649 billion for Vanguard, an astonishing 38 percent of the total TDF marketplace.
CITs one way to stay active
Nine providers of actively managed TDFs now have lower cost, passive-based versions of legacy funds.
One way to keep an actively managed style competitive is to offer the strategy in CIT form.
“The active manager is trying to outperform the market,” said Holt. “Active is like a hurdle—the lower the cost, the lower the hurdle, because active managers have to outperform the market net of fees.”
Of 10 TDF series that offer an indexed version of a legacy actively managed TDF, the passive version tended to outperform. But in three cases the active funds bested their passive counterparts. “Investors would have been better off sticking with the higher cost funds in those cases,” said Holt.
Managers that put their money where their mouth is do so in active funds
For all of the demand for lower cost indexed TDF strategies, a small cohort of active TDF managers still believes the cost of trying to beat the market is money well spent.
Of the 140 TDF managers Morningstar tracks, only 16 invest $1 million or more of their own money in the funds they manage, something Holt said is “quite telling.”
Six managers run multiple TDF series—both an active and passive focused strategy. Of those, four chose to invest more than $1 million of their personal money in active strategies, and the other two invest at least $1 million in active and passive series.
“Firms believe in their active management philosophy and they believe they will outperform indexes,” said Holt. “At the end of the day, it appears investors are gravitating to the TDF series that the managers don’t have as much conviction in.”
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