Within TDFs it is important to understand that there are two investment architectures: open and closed. An open architecture will include both in-house or proprietary funds of the manager as well mutual funds managed by other firms. A closed architecture is a fund in which there are limited mutual funds within the TDF and most are operated by a single firm providing the product.
The Pros and Cons
There are also arguments against each fund architecture. Opponents of open funds say they can be expensive and difficult to research. There is also the chance for “over-diversification” which can be confusing to novice investors. On the other hand, critics of closed architecture say the style can cause conflicts of interests if too much money is being invested in-house simply to raise company profit, and there is the possibility of too little diversification if only one manager is being used.
In July 2014, Morningstar released its Target-Date Series Research Paper. In it they said, “Open architecture series should have the ability to draw from the industry’s best, but these series have shown no performance advantage over closed-architecture series.” Interestingly, however, it is fees that come into play when looking at returns, with the implication that closed funds are more attractive to the cost-conscious investor. The report continues: “Open-architecture series pay systematically higher fees to access non-proprietary managers, and those costs eat into returns.”
Some of the biggest TDF providers in the U.S. are Fidelity Investments, Vanguard, and T. Rowe Price. The Fidelity Freedom K 2020, 2030, 2040 and 2050 funds have an average compound return of 9.3% for the five years ending March 31, 2015. Vanguard’s Target Retirement 2020, 2030, 2040 and 2050 funds have a compound return of 10.4% over the same time period. Both are closed-architecture funds.
The Bottom Line
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