Cost Versus Value as a Factor in Target Date Fund Evaluation | Capital Group

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Defined Contribution Insights

March 2015

Cost Versus Value as a Factor in Target Date Fund Evaluation

“Small differences in investment fees and costs can have a serious impact in reducing long-term retirement savings.”

— U.S. Department of Labor

Meeting DOL Guidelines, Article 3 of 5

Satisfy DOL guidelines with a participant-focused approach to evaluating target date funds.

Authors:

Wesley Phoa, portfolio manager, target date and fixed-income funds, 21 years of experience.

Jason Bortz, ERISA attorney, 17 years of experience.

Toni Brown, CFA senior defined contribution specialist, 25 years of experience.

John Doyle, senior defined contribution specialist, 28 years of experience.

Rich Lang, investment specialist, 21 years of experience.

Years of experience as of December 31, 2014.

Target date funds have enormous potential to make defined contribution plans more effective and straightforward for participants. But to capture the funds’ benefits — and to help meet fiduciary obligations — plan sponsors must implement thorough, well-documented evaluation procedures.

The U.S. Department of Labor has made it clear that plan sponsors must carefully evaluate target date series before adding them to a plan’s investment lineup, periodically re-evaluate any target date funds currently offered by the plan and document the process.1 Yet evaluating and understanding target date funds can present challenges to plan sponsors. Although the funds are designed to make retirement investing simple and convenient for plan participants, their underlying construction can be complex and can vary widely among the dozens of series on the market.

We believe that plan sponsors’ evaluation process should encompass the following five considerations:

  1. Participant Needs

  2. Glide Path Construction

  3. Cost Versus Value

  4. Quality of Underlying Funds

  5. Consistency and Repeatability

In this series of five articles, we walk plan sponsors, consultants and retirement plan advisors through each of the five components of the evaluation process. Thorough, effective target date fund evaluation will help plan sponsors fulfill not only the letter of the fiduciary rules, but also their intent: to give participants the best opportunity to meet their retirement saving and investing needs.



Consideration 3: Cost Versus Value

Plan sponsors have a fiduciary responsibility to ensure that their participants are not overpaying for the investments in the plan. There is a tremendous range in fees among the target date funds on the market (see the Expense Ratios for Target Date Series chart below.) Likewise, fees may vary significantly between different share classes. When considering any fund series, plan sponsors must understand where it falls on the fee spectrum.

Fees alone don’t tell the whole story, however. Plan sponsors and other stakeholders should consider the value a given series has provided to participants relative to its fees. If one fund’s fees exceed another’s by 10 basis points, but the fund has consistently provided a 30-basis-point advantage in annualized returns, participants may be better served by the slightly more expensive option.

Plan sponsors can gauge value by comparing expenses with returns over rolling periods. A target date series may be relatively attractive from a value perspective if it has consistently generated excess return relative to its peers and is not commensurately more expensive. Creating a scatter graph that plots excess returns against expenses can visually demonstrate the value that fund series have provided for their costs.

Ideas for Action

  • Check fees against other target date series
  • Check fees of different share classes
  • Graph fund series’ excess return against expenses for a visual demonstration of value

Expense Ratios for Target Date Series Vary Significantly

The chart illustrates the asset-weighted average expense ratio (across all share classes) for major target date series in 2013.

Source: Morningstar®, Inc, “2014 Target-Date Series Research Paper,” July 2014.

This information is intended to highlight issues and not to be comprehensive or to provide advice.

1 U.S. Dept. of Labor, “Target Date Retirement Funds — Tips for ERISA Plan Fiduciaries,” February 2013.

 


Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.

Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses or the collective investment trust's Characteristics statement, which can be obtained from a financial professional, Capital or your relationship manager, and should be read carefully before investing. 

Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and not to be comprehensive or to provide advice. Investors should consult their tax or legal advisors. 

The Capital Group companies manage equity assets through three investment groups. These groups make investment and proxy voting decisions independently. Fixed income investment professionals provide fixed income research and investment management across the Capital organization; however, for securities with equity characteristics, they act solely on behalf of one of the three equity investment groups.