Innovation in the financial services industry happens frequently. While innovation is generally good for investors, conflicts of interest can and do arise, and if left unchecked, they can end up being detrimental to investors. One area where conflicts of interest are being brought to light are with target-date investment funds (TDFs). TDFs were created for the purpose of helping investors focus on long-run investing by gradually rebalancing the portfolio from equities into safer assets (e.g., bonds) as the investor approaches retirement. The simplicity of this algorithmic long-term “glide path” rebalancing, along with acceptance in employer-sponsored defined contribution plans, has been a boon for the industry with total assets under management of $1.4 trillion at the end of 2019.
Because TDFs typically invest in underlying pooled investment vehicles managed by the same fund family and not individual stocks and bonds, this article from the Institutional Investor examines if this “closed-architecture fund system” can be detrimental to investors. Not only did the study find that flow-performance sensitivity decreased as the TDF horizon lengthened, but time horizon was also negatively correlated to performance. For example, a ten-year increase in the time horizon corresponded with a performance drag of 29 basis points in net annual performance. Furthermore, the study concluded that TDF managers engage in fee skimming through higher fees charged on the underlying mutual funds selected by the TDF, effectively subsidizing the underlying funds managed by the same family.
So, while TDFs aim to make the process of investing for retirement easier for individuals, until there is a movement toward increased open architecture for the TDFs, investors will be responsible for their own due diligence on fees and performance.
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