An Unlikely ETF Revival

September 10, 2018

On paper, target-date ETFs sounded great. ETFs offer flexibility, transparency, low cost—why not use them to save for retirement?

But target-date ETFs never quite got off the ground. In 2014, BlackRock shuttered its entire line of iShares target-date ETFs, after they'd gathered just $310 million in assets in six years. Deutsche liquidated its Xtracker target-date ETFs a year later.

No target-date ETFs have launched since.

Today however, ETFs are making a comeback in the target-date fund space—not as the wrapper, but as the holdings. By deploying ETFs inside target-date funds, providers can lower costs of those funds dramatically, easing the burden on cost-conscious investors and opening up possibilities for retirement plan sponsors of all sizes.

What Are Target-Date Funds?

Essentially, target-date funds offer a one-size-fits-all approach to saving for the future. A single fund contains a blend of stocks, bonds and cash, the allocation of which shifts as time nears some preset date.

Target-date funds that are further from their predetermined end dates will aggressively allocate to stocks—sometimes as high as 95-99%—then rebalance more to fixed income and cash as the target date nears. Once the predetermined date hits, the fund usually rolls over into a general-purpose "retirement fund" with a static, conservative stock/bond mix.

Though target-date funds lack the customizability of an individualized investment portfolio, they also remove much of the headache: Investors don't have to worry about what to buy when, and there is no temptation to panic-sell in times of market volatility. Investors don't even have to engage with an actual person, if they don't want to. (In that regard, target-date funds are like the spiritual predecessor to a robo advisor.)

As such, target-date funds have been widely adopted as the default choice for 401(k) plans and other defined-contribution (DC) programs. According to the Investment Company Institute, there was more than $1.1 trillion in assets under management in target-date mutual or collective funds at the end of 2017.

Short, Happy Life Of Target-Date ETFs

Once upon a time, investors also had the option of target-date ETFs. Both iShares and Deutsche Xtrackers offered a full suite of target-date ETFs. But that experiment proved short-lived.

"Our target-date ETF closures in 2014 were based on an ongoing process to review our product lineup and ensure it meets the evolving needs of its clients," said Melissa Garville, a spokeswoman for BlackRock, in an email statement to ETF.com.

Essentially, target-date ETFs were a case of the right idea in the wrong vehicle, says Todd Rosenbluth, director of ETF and mutual fund research at CFRA: "Some of the benefits of ETFs are lost through a 401(k) wrapper."

For starters, target-date funds are meant to be bought and held for decades. ETFs, meanwhile, can be traded intraday, just like stocks. "[ETFs'] intraday liquidity is not a benefit for retirement plans," noted Rosenbluth.

Secondly, target-date funds are the rare example of where ETFs aren't necessarily cheaper than mutual funds. Large retirement plans can access institutional share classes of mutual funds, which are priced as low—or sometimes lower—than ETFs. Plus, institutional shares can be bought inside a plan without the additional cost of a trading commission (which was more of a concern back in the days before widespread commission-free ETF trading).

Finally, most 401(k) plans and other DC accounts were and still are built for mutual funds. Even if plan sponsors wanted to use ETFs, the infrastructure simply can't accommodate them yet. That means investors would have needed to use target-date ETFs in personal accounts held outside the retirement plans offered through their workplace, an extra step that a smaller number of employees were willing to take.

Stair-Stepping Through Risk

That's not to say ETF investors haven't been able to cobble together something similar to the target-date fund experience. While not an exact one-to-one comparison, target-risk ETFs, which provide exposure to a consistent level of risk, give investors the ability to step through various risk tolerances over time.

Unlike target-date funds, the portfolio allocation within a target-risk ETF generally stays the same. Investors can select a risk-tolerance level, then manually move through "aggressive," "growth," "moderate" and "conservative" portfolios, as their risk tolerance changes closer to retirement.

"Unlike target-date funds that presume all investors seeking retirement in 2040 have the same risk tolerance,” added Rosenbluth, “these products presume investors know how much volatility they can stomach, without a clear end date in mind."

Both iShares and Invesco offer suites of target-risk ETFs, inside which are baskets of the company's other ETFs. As such, each target-risk ETF within a family typically holds the same set of ETFs, just in differing amounts.

For example, the largest target-risk ETF, the $1.1 billion iShares Core Growth Allocation ETF (AOR), which aims to enact a 60/40 growth strategy, holds the same seven ETFs as the $916 million iShares Core Moderate Allocation ETF (AOM), which enacts a 40/60 allocation. However, whereas AOR has 34% of its portfolio in IUSB and 29% in IVV, AOM has 50% of its portfolio in IUSB and 20% in IVV.

 

Portfolio Holdings Of iShares Target-Risk ETFs (%)
  AOR AOA AOM AOK
IUSB 33.66 16.78 50.49 59.12
IVV 29.44 39.13 19.63 14.77
IDEV 21.67 28.80 14.45 10.88
IAGG 5.93 2.96 8.90 10.42
IEMG 5.80 7.71 3.87 2.91
IJH 2.24 2.97 1.49 1.12
IJR 1.03 1.37 0.69 0.52
Cash 0.21 0.27 0.48 0.26
         
Total % Stocks 60.18 79.98 40.13 30.20
Total % Bonds/Cash 39.80 20.01 59.87 69.80

Source: Issuer data; data as of Sept. 5, 2018

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