Two of the largest managers of target-date-fund assets, Fidelity Investments and American Century Investments, are changing how they assess fees in the multi-asset funds, at a time of heightened cost scrutiny and as TDFs capture an increasing portion of 401(k) contributions.
The two asset managers are the first among their peers to switch to a "single fee" management structure in their target-date mutual funds, analysts said. This structure allows the firms to charge a fixed fee for their TDFs, irrespective of the underlying funds that make up the portfolios.
Target-date managers have historically used an "acquired fee" model, whereby firms determine the cost of the overall portfolio based on the asset-weighed cost of the underlying funds.
For example, a portfolio of two mutual funds, one costing 0.5% and the other 1%, both with the same amount of assets, would have an overall cost of 0.75% under the acquired-fee approach.
But, adding a relatively expensive strategy, perhaps a liquid-alternative portfolio, could increase the expense ratio by several basis points, making the TDF less attractive to 401(k) advisers and plan sponsors, said Chris Brown, the founder and principal of Sway Research, which studies asset management distribution in defined contribution plans.
The single-fee method doesn't impose such limitations — asset managers are free to add whichever asset classes they like to the portfolios, with an eye toward enhancing performance, without sacrificing on cost marketability, Mr. Brown said.
"Target-date managers are trying to find any and every way they can to compete on costs," said Jeff Holt, multi-asset analyst at Morningstar Inc.
Fidelity and American Century are respectively the No. 2 and No. 8 TDF managers by mutual fund assets.
Fidelity changed the management fee structure for its Fidelity Freedom and Fidelity Advisor Freedom TDF series in June, and American Century's switch is expected later in 2017, Mr. Holt said.
Fidelity has two other series — Fidelity Freedom Index and Fidelity Multi-Manager — to which the changes don't pertain. The Fidelity Freedom funds hold the lion's share of its TDF assets, at 82%. American Century has one series, the One Choice funds.
Both firms fall into the camp focused on active management of their funds. They use underlying stock and bond funds engaged in the active selection of securities, whereas firms focused on passive management use funds that track an index like the S&P 500.
Active managers tend to asses higher fees than passive managers. As advisers and plan sponsors have sought out lower fees, due in part to the proliferation of lawsuits attacking plan fees and growing importance of fee transparency, flows to index funds have
dominated those of active funds — roughly two of every three dollars directed to TDFs in 2016 went to a passive series, according to Morningstar.
Since 2006, assets held in passive TDFs have doubled to roughly 40% of total target-date mutual fund assets, whereas those held in active funds have dipped to 60%, from more than 80%, according to Morningstar.
Target-date mutual funds held $880 billion in assets at the end of 2016.
"At the end of the day, investors want lower fees. This is just another way to get there," Mr. Holt said of the single-fee management style.
Of course, there's always the concern firms will charge more than the underlying funds, but thus far it appears to be an effort to lower costs or afford the flexibility to lower costs, Mr. Holt added.
Target-date-fund marketability
is only becoming more important as TDFs swell in popularity. As of 2016, the funds accounted for around one-half of all 401(k) contributions, according to Cerulli Associates. By 2020, Cerulli projects that 401(k) participants will direct 75% of all contributions to TDFs.
American Century
managed to notch one of the largest annual TDF gains last year, in percentage terms, among its competitors despite its active-management focus.
Despite some of the advantages a single-fee approach affords asset managers, Mr. Holt doesn't expect it to catch on among other firms any time soon.
That partly stems from the effort it could take to achieve the end result — American Century, for example, is launching a share class of its underlying funds, exclusively for its TDFs, with no fees, allowing the firm to charge a fixed fee for the whole portfolio, Mr. Holt said.
Fidelity, though, is waiving underlying fund expenses in the new fee structure, Mr. Holt said.
