Target Date Fund Selection: More Than Simply Active vs. Passive

Executive Summary

  • While choosing between active and passive target date funds is important for a plan sponsor, it is only one consideration among many that ultimately drive participant outcomes
  • Decisions around a target date fund’s glide path and asset allocation — active choices that even passive target date funds must make — likely will have much more impact on participant outcomes than the potential cost differences between the active or passive portfolios underlying the fund
  • A fiduciary’s responsibility includes providing participants with a suitable selection of investment choices, both across a plan’s lineup of investment options and within its target date offering
  • Passive target date managers tend to offer less breadth and depth in asset class choices, particularly with respect to non-traditional or alternative asset classes
  • Tactical asset allocation — the freedom to deviate from long-term allocation policy to capture shorter-term opportunities — is a potentially valuable practice that is often missing from passive target date funds
  • In choosing between active, passive or blend funds, sponsors should weigh all potential benefits and drawbacks of the various methods — not only fees — since diversification, tactical flexibility, alpha potential in different asset classes and suitability for participants may all be affected


Over the past decade, target date funds have moved from the fringes of the defined contribution world to the mainstream. Selecting a target date fund has become one of the most important decisions a plan sponsor will make on behalf of plan participants. Despite this shift into the mainstream, significant differences in investment philosophies and processes among managers have produced wide dispersion in performance and risk over time. What’s more, unlike equity and bond asset classes, target date funds do not have an accepted industry-wide benchmark with which to compare and contrast historical results (such as the S&P 500 Index for U.S. large-cap equity managers). Therefore, as the Department of Labor outlined in its 2013 target date bulletin, plan fiduciaries should thoroughly review all aspects of their target date fund situation and document that fund selection and monitoring have produced a plan that is the right fit for plan participants.1

One aspect of target date design that has received a lot of attention recently is whether the underlying funds are 100% actively managed, 100% passively managed or a blend of the two approaches. While this feature of target date design is unquestionably important — it impacts both performance and fees — it is only one consideration among many that ultimately will drive participant outcomes. In fact, passive target date funds are a bit of a misnomer; regardless of whether the underlying portfolios that comprise a fund are managed actively, passively or a blend of both, all target date managers make numerous active decisions that significantly impact performance and risk. These include:

  • Glide path construction
  • “To vs. through” landing points
  • Asset allocation
  • Asset class breadth
  • Tactical or static asset allocation approach
  • Portfolio construction and management

As a result, unlike an equity or bond fund in which a preference for active or passive may be based mainly on fees or a belief about the value of active management, a target date fund’s use of active, passive or blend strategies should not be the sole or even primary determinant for selection. In fact, one could argue that decisions such as glide path and asset allocation will have a much larger impact on participant outcomes than the fee differential between active and passive target date funds. As can be seen in Figure 1, the average performance dispersion between managers in each Morningstar Target Date category over the past five years has been as high as 8%, far in excess of the approximately 0.40% annual fee differential between passive and active target date funds.

In this paper, we examine this active/passive debate relative to the other design choices and discuss some of the tradeoffs between active, passive and blend approaches within the target date space.

Figure 1. The Range of Returns across Target Date Funds is Remarkably Wide
Figure 1. The Range of Returns across Target Date Funds is Remarkably Wide

Source: Morningstar Direct
© 2018 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; (3) does not constitute investment advice offered by Morningstar; and (4) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. Use of information from Morningstar does not necessarily constitute agreement by Morningstar, Inc. of any investment philosophy or strategy presented in this publication.
Data as of March 31, 2018

1 “Target Date Retirement Funds – Tips for ERISA Plan Fiduciaries,” United States Department of Labor, Employee Benefit Security Administration,, February 2013.

Investment Risks
There are no guarantees a diversified portfolio will outperform a non-diversified portfolio. Diversification does not guarantee a profit or ensure against loss. Past performance is no guarantee of future results.

Inherent in all investing are the risks of fluctuating prices and the uncertainties of rates of return and yield. A target date is the approximate date when investors plan to start withdrawing their money; principal value fluctuates and there is no guarantee of value at any time, including at the target date.

Price volatility, liquidity and other risks accompany an investment in equity securities of foreign, smaller capitalized companies. International investing poses additional, special risks including currency fluctuation, economic and political risks not found in solely domestic investments. For investments in emerging markets, such foreign investing risks are generally intensified.

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