Is Passive Truly the Safer Fiduciary Choice for TDFs? | Capital Group

Defined Contribution Investment Perspectives

Is passive truly the safer fiduciary choice for TDFs?

Given the rapid acceptance of target date funds (TDFs) as the primary retirement investment strategy for American workers, the choice of target date provider is now among the most important decisions for an investment committee.

The beauty of a TDF is its simplicity for participants. However, its underlying complexity can challenge committees tasked with assessing a TDF’s glide path design, risk/return profile and fee structure as part of fiduciary due diligence.

One of the considerations is whether the TDF should be actively or passively managed. In either case, appropriate due diligence must be conducted. When selecting a TDF provider, sponsors should remember:

  • Passive management does not provide inherent fiduciary protection.
  • Managed investment strategies may lead to better participant outcomes.
Jason Bortz
Jason Bortz Associate Counsel Los Angeles office 21 years of experience (as of 12/31/18)
Toni Brown
Toni Brown Senior Defined Contribution Specialist San Francisco office 30 years of experience (as of 12/31/2019)
John Doyle
John Doyle Senior Defined Contribution Specialist New York office 33 years of experience (as of 12/31/2019)
Sue Walton Senior Defined Contribution Specialist Chicago office 22 years of experience (as of 12/31/2019)

Passive management does not provide fiduciary protection

Fiduciaries sometimes view passive strategies as “safer” choices out of concern over fees. Fees are an important consideration in the selection of a TDF provider, but not the only one. What ultimately matters are economic outcomes for participants.

As such, fiduciaries should analyze how a target date series is structured to deliver the best value for participants. Some factors to consider include:

  • The glide path design
  •  The ability to manage risk
  •  The potential to deliver above-average returns

No target date fund is completely passively managed

All target date providers make active asset allocation decisions when creating the glide path. This has a big impact on risk and return.

The chart below shows how TDFs composed of mostly passive underlying funds have a wide range of equity exposures at age 65, the age at which a participant is assumed to retire and begin taking withdrawals. Note the equity allocation at retirement ranges between 8% and 58%. Because asset allocation can drive results, fiduciaries should review the change in allocations along the glide path as the fund moves closer to its target date.

Equity exposure can vary widely in passive TDFs Percentage of assets in equity (as of 12/31/18)


Source: Capital Group, based on Morningstar data. Based on the eight target date series that have a three-year history and no more than 20% of assets actively managed.

Five questions for evaluating target date funds

  1. How is the glide path constructed?
    Analyze how equity and fixed income work together along the glide path.
  2. What are the needs of participants?
    Balance the need for growth with the desire for volatility control relative to plan demographics.
  3. What underlying funds are used in the series?
    Review the long-term results of the underlying funds through market cycles.
  4. What types of risk does the target date series exhibit?
    Review such key risk characteristics as market, longevity, interest rate and sub-asset class risk.
  5. How much do participants pay for the funds?
    Determine the value received for the fees charged.


Passive investments do not have inherently greater fiduciary protection than active investments. When selecting TDFs, sponsors should evaluate a range of criteria, including:

  • The glide path, including the quality and type of equity and fixed income exposures as they change over time.
  • The investment process, including the level of managerial ownership and oversight.
  • Fees relative to comparable strategies and value received.

Taking an active approach to target date selection can help sponsors meet their fiduciary responsibilities while facilitating sound and productive retirement savings for their workers.


Standard and Poor’s 500 Composite Index is a market capitalization-weighted index based on the average weighted results of 500 widely held common stocks. MSCI All Country World ex USA Index is designed to measure results of more than 40 developed and emerging equity markets, excluding the United States. The market indexes are unmanaged and, therefore, have no expenses. Investors cannot invest directly in an index. Past results are not predictive of results in future periods.

Least expensive quartile was calculated using annual report net expense ratio (NER) for all observed Morningstar categories for the 20-year period indicated. For funds with missing expense ratios, gaps between two available data points were filled in using linear interpolation. Linear interpolation is a statistical method used to estimate the values between two known data points in a time series. Highest manager ownership quartile was calculated using weighted averages of Morningstar screens of manager holdings at the firm level. Each fund was assigned the weighted average of its firm manager holding. Funds without values were excluded from the quartile rankings. The combination of least expensive NER and highest manager ownership quartiles (the Select Equity core) was the result of a cross-section of the two screens. Only those funds with both the lowest expense ratios and the highest manager ownership were included.

The database built to represent the universe of both large-cap domestic and large-cap foreign funds drew from Morningstar’s U.S. Open-End Large Value, Large Blend and Large Growth U.S. and Foreign categories, with live and dead funds combined to eliminate survivorship bias. For live funds, only the oldest share class was used. The oldest share class designation used in the screening process does not reflect the recent Morningstar methodology change for funds incepted prior to 12/31/2015, as it is based on a previously existing database of Morningstar fund identifiers. Funds incepted after that date are identified with Morningstar’s new methodology. For dead funds with multiple share classes, the median monthly returns were used. If a sales charge had been deducted, results would have been lower. For fee-related illustrations that include dead funds with multiple share classes, the median expense ratios were used. We searched Morningstar’s database for large-cap actively managed funds that were in both the lowest quartile ranked by expense ratio and the highest quartile ranked by manager ownership at the firm level. Past results are not predictive of results in future periods.

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