Dan Oldroyd, Portfolio Manager and Head of Target Date Strategies discusses insights on the passive target date funds market.
Passive target date funds (TDFs) grew to a trillion-dollar-plus market on the strength of two big ideas: that investors pay the lowest possible fee; and that asset values increase when interest rates are low. This was never a realistic promise in the fixed income arena. And then interest rates shot up.
Dan Oldroyd, Portfolio Manager and Head of Target Date Strategies at J.P. Morgan, explains why it’s time for consultants, advisors and plan sponsors to re-underwrite default decisions in 401k and defined contribution plans.
How do you view the passive TDF market?
These funds have always been marketed as a way for investors to achieve reasonable outcomes in retirement accounts at the lowest possible fee. But the underlying investment strategy is not what most people assume it is. That is, it’s not truly passive. Plus, in the now-higher interest rate environment, thoughtful active managers have new opportunities to generate excess returns, which passive funds may be missing.
Why the need for action now?
Consultants, advisors and plan sponsors generally re-underwrite fund selections every three to five years. A lot of players went passive in fixed income one, two, three, four, five, or six years ago. Given that interest rates are likely to remain high for the foreseeable future, now is a good time to re-evaluate the funds in clients’ retirement accounts. If further incentive is needed: In this same time period, active fixed income managers added a lot of value – and passive TDF investors left money on the table.
What makes passive target date funds less optimal?
In the passive equity arena, managers can buy an entire index. That’s how you know you’re going to get the performance of the index.
That’s not possible in fixed income, where even bonds from a single issuer can have different tenors, different terms, different yields. As a result, managers use sampling to get the best approximation of the index; for example, holding 8,000 or 10,000 of the 14,000 names in the Bloomberg Aggregate Bond Index.
Also keep in mind: An equity manager buying the S&P 500 is getting an index weighted by how much companies are growing. Passive fixed income funds are weighted to companies issuing the most debt. How many investors would knowingly want to lend money to companies with the most debt?
Are passive TDFs really passively managed?
No! “Passive” here refers to the underlying strategies managers invest in to keep fees low; typically, low cost index funds. However, when it comes to asset class diversification, glide path design, investment strategy selection and portfolio construction, all TDFs are actively managed strategies.
Does this heighten diversification risk?
As noted above, to keep fees lows, TDFs typically shun asset classes that are more difficult or expensive to replicate, such as high yield bonds and real estate—even though, historically, these assets have been extremely additive to long-term performance.
Where do you see opportunity?
In active management. There’s an inherent opportunity for asset managers who are skilled and well-resourced to generate excess returns by developing an information advantage.
For example, at J.P. Morgan, we’ve been able to consistently generate 30 to 40 basis points of excess returns, net of fees, in our Core Bond and Core Plus funds.
What’s your advice for fund managers?
The market prioritizes low fees and “safe outcomes” – a strategy that, in part, aims to protect fund managers from being sued. But what investors more typically get is the lowest fee and a lot of active management, with all of the attendant opportunities and risks.
My advice to fund managers and fiduciaries: Focus on the value of a fund’s approach and don’t discount risk management and outcomes. It will be a more productive starting point than searching for the lowest fee.
Core Bond Fund (R6 shares)
