USD Professor of Finance Cited in Financial Times

Financial Times logoUniversity of San Diego Assistant Professor of Finance William Beggs
begin quoteProfessor William Beggs says that the use of in-house funds as underlying investments can compromise performance, pointing out that target-funds providers who fill their target-date funds with their own investment strategies have little incentive...

William Beggs, assistant professor of finance, was cited in the Financial Times for his insight on how conflicts of interest in the management of retirement assets negatively impacts financial portfolio performance.

Conflicts of Interest in Target-Date Funds Catch SEC’s Eye

From lawsuits for high fees to regulatory probes into the way funds are sold, the US asset management industry has been attacked on multiple fronts in recent years.

But one area that has largely escaped unscathed up until now is the $1.7tn target-date fund market, which has experienced runaway growth and is a central plank of the US defined contribution retirement system.

Target-date funds — retirement portfolios that rebalance automatically according to the investor’s age and target retirement date — account for almost a third of assets held in US employee retirement plans, according to Callan Associates, a consultancy.

Yet critics fear target-date funds could be an accident waiting to happen, warning that concentration and competition issues are putting investors at risk.

“Target-date funds have very much been under the radar,” says Chris Brown, founder and principal of Sway Research, a consultancy focused on fund distribution within 401(k) plans. “This has allowed the big captive providers to get bigger and bigger.”

The target-date market is controlled by a small number of asset managers. The top three providers — Vanguard, Fidelity Investments and T Rowe Price — manage 63 per cent of the total asset pool, according to Sway Research. In addition, the vast majority of target-date managers exclusively invest in their own in-house funds, with just one provider in the top 10 — Principal — outsourcing the portfolios to external managers.

One reason for the closed nature of the market is downward pressure on management fees. The average fee for target-date funds fell to an all-time low of 0.62 per cent in 2018, down from 1.03 per cent in 2009, according to Morningstar. The squeeze has forced target-date providers to prioritise in-house funds over external managers to save money.

“Ten years ago if you had a well-constructed ‘best of breed’ multi-manager fund, you had an advantage,” says Jim McCaughan, former chief executive of Principal Global Investors. “Now that’s less the case because of the intense focus on price.”

The conflicts of interest inherent in this model are rising up the US Securities and Exchange Commission’s agenda. The agency’s compliance inspections and examinations unit this month issued a rare warning following a one-off review of target-date funds, criticising managers for failing to properly disclose conflicts resulting from the use of in-house funds.

This issue has taken on particular urgency given the increasing proportion of US workers being channelled into target-date funds as default investment choices. Since the landmark Pension Protection Act was introduced in 2006, US employees are automatically enrolled in 401(k) plans if they are available. The rise of target-date funds was sparked by the change of legislation, as the products responded to a need for default investment options.

“The stamp of approval that came with the Pension Protection Act really opened the floodgates for target-date funds,” says Jeff Holt, director of multi-asset and alternative strategies for Morningstar.

Morningstar’s research shows that target-date funds have more than quintupled their assets under management over the past decade, during which they have regularly recorded double-digit annual growth. “The fact that so many retirement investors are relying on them is what has brought them to the SEC’s attention,” says Mr Holt.

Investors’ hands-off approach to target-date funds — designed as simple, “set it and forget it” investments — gives specific impetus to investor protection concerns.

“The assumption is that those investors don’t dig into portfolios or look at what they are invested in,” says Mr Holt. “Because of that it is much more important that investors aren’t misled as to what they’re getting.”

Chief among the questions regulators will be asking about target-date funds is whether they deliver good investor outcomes. William Beggs, assistant professor of finance at the University of San Diego School of Business, says that the use of in-house funds as underlying investments can compromise performance, pointing out that target-funds providers who fill their target-date funds with their own investment strategies have little incentive to fire the underlying manager if returns tail off.

Research by Mr Beggs found that the presence of conflicts of interest in the management of retirement assets materially impacts performance. Target-date funds run by managers who also provide investment consulting services to 401(k) plans underperformed conflict-free funds by 40 to 50 basis points per year.

In recent years, financial services groups such as Prudential, American Century, BlackRock, Goldman Sachs and Putnam Investments have been hit by lawsuits from employees over...


Renata Ramirez
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