Smaller players foundering in target date fund market

More than twice the number of target date funds have liquidated this year than in all of 2008, indicating how difficult it is for asset managers unaffiliated with 401(k) record keepers to build assets in such funds.

So far in 2009, there have been 15 liquidations, up from seven for all of last year, according to data culled from Morningstar Inc. Moreover, experts predict that trend to increase.

Payden & Rygel, Old Mutual Asset Managers and Allstate Insurance Co. are among a growing number of firms that have liquidated their target date funds or are planning to do so.

“I have heard of a few managers’ pulling back,” said Lori Lucas, executive vice president and defined-contribution practice leader for Callan Associates Inc., an institutional-investment consultant. “Some managers are discussing scrapping their own target date funds in favor of being part of custom target date portfolios or as subadvisers to these funds.”

Target date funds are sold predominantly in the 401(k) market. The biggest sellers of these funds tend to be those firms that act as record keepers for 401(k) plans.

If all but a handful of the available target date funds are those offered by the top 401(k) record keepers, it will help financial advisers who serve this market to pitch the value of customized portfolios to their plan sponsor clients, some experts contend. But less competition may also mean less innovation among such funds, others fear.

Gill Armour, a financial adviser with independent-contractor broker-dealer SagePoint Financial Inc., said that he will be disappointed to see fewer choices in the target date fund market.

“It’s just going to mean more work for advisers like me” who work with plan participants, he said. “We are going to have to do more customization of portfolios.”

Another concern is that less competition will mean less innovation.

“We look toward some of the smaller target date fund series for alternative asset classes, whereas the bigger ones are very plain-vanilla,” said Christian Bretz, an investment and operations manager for Wells Fargo Insurance Services Inc. “I worry about innovation.”

“HARDER TO COMPETE’

“Target date fund providers that don’t have record keeper affiliations are finding it harder to compete, and as a result, more are going to shut down,” said Benjamin F. Phillips, a partner and director of research at Casey Quirk & Associates LLC. “This gives advisers more of an incentive to offer customized portfolios to 401(k) plan clients.”

Customized target date options will hold $1 trillion by 2019, compared with $53 billion today, according to a white paper published last week by Casey Quirk.

The issue is that the top 401(k) record keepers dominate the target date fund market, critics said.

In response to hearings held Oct. 28 by the Senate Special Committee on Aging on conflict-of-interest issues associated with target date funds, the Investment Company Institute said a statement: “Plan sponsors can choose whether or not to use target retirement date funds offered by the plan’s record keeper.”

But non-proprietary funds are rarely chosen, according to research conducted exclusively for InvestmentNews by BrightScope Inc., a 401(k) data and analytics firm.

Across a sample of 1,347 plans handled by the top four record keepers with target date funds, 94% of plans held only the record keepers’ target date funds. That number hits 100% for plans managed by The Vanguard Group Inc., 97% for plans run by T. Rowe Price Associates Inc., 94% for plans run by Fidelity Investments and 93% for plans run by Principal Financial Group.

“The question is, do 90% to 100% of plans really think that the target date funds they offer are the right funds for their plans?” said Ryan Alfred, co-founder and president of BrightScope.

Recent Morningstar ratings of these target date fund providers bear out Mr. Alfred’s statement. Fidelity’s target date funds received an average rating and Principal’s a below-average rating. The firm gives T. Rowe and Vanguard top ratings for their target date funds.

“I don’t think Fidelity has its best funds in its target date fund series,” said Laura Lutton, an analyst at Morningstar. “And Principal is a bit of a mixed bag.”

“We absolutely stand by our product,” said Jennifer Engle, a spokeswoman at Fidelity. “When people hire Fidelity, there is a reason they do so.”

PRICING POLICIES

Pricing for outside funds in Fidelity-run 401(k)s depends on the plan, she said.

Ed Giltenan, a spokesman for T. Rowe Price, declined to comment on whether the firm charges more for plans to choose outside funds.

Jaime Naig, a spokeswoman for Principal Investments, was unavailable for comment. The firm’s LifeTime Series does offer funds managed by outside managers as well as its own.

“We believe our funds are best-in-class, and [we] do not currently record-keep non-Vanguard target date funds,” said Linda Wolohan, a Vanguard spokeswoman.

But even if plans do have access to outside target date funds and are willing to pay more to get them, their choices will continue to shrink.

“Asset managers tell us that a fund must have $100 million to $150 million in assets to be profitable,” said Cindy Zarker, a director at research firm Cerulli Associates Inc.

Excluding funds launched this year, there were 328 target date funds as of Sept. 30, according to Strategic Insight/Simfund data culled by Cerulli. Of those, 176 had less than $100 million in assets.

Payden & Rygel closed its Payden/Wilshire Longevity funds Oct. 15 after less than three years in the market. The four funds, launched in July 2007, had $10 million in assets.

The firm decided to close the funds “to focus on the core business,” said Kimberly Tipton, a spokeswoman.

Old Mutual filed in September with the Securities and Exchange Commission to shut down its 12 target date funds. These funds, which had a combined $4.5 million in assets, will close in December, according to the filing.

Allstate liquidated its seven life cycle funds in June, 13 months after they were launched. The funds had a combined $1.9 million in assets.

E-mail Jessica Toonkel Marquez at [email protected].