Companies compete to bring lowest cost TDFs to market

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Charles Schwab Investment Management made waves late last month by introducing the lowest-cost target-date funds on the market with an across-the-board expense ratio of 8 basis points and no minimum investments for any size retirement plan.

For individual investors purchasing the plan, the cost is 13 basis points with only a $100 minimum investment.

The average target-date fund on the market today charges 73 basis points, which up until now, was considered very low cost. Some in the industry question how Charles Schwab can make any money charging 13 basis points.

Ron Surz, CEO of Target Date Solutions in San Clemente, Calif., believes Charles Schwab is gambling that it will attract a certain level of assets to make its low-cost offerings worthwhile.

“I can’t imagine how they can make money on that unless they reach $20 billion,” he says.

In the race to offer the cheapest TDF option, Surz says he “can’t imagine anyone going lower than 13 basis points. We’re trying to get our fees down as low as we possibly can. We can get fees under 10 basis points for managers but it is hard to do if you have diversifying assets like real estate.”

He added that when a company adds paying the custodian and overlay manager, 3 basis points is really lean. “They are trying to buy the business,” he says.

Jake Gilliam, senior multi-asset class portfolio strategist for Charles Schwab Investment Management, says that his company’s offering came about because “there has been a laser focus on fees from plan sponsors, consultants, advisers and the like, and the industry has continued to scrutinize the fees they are paying following the rules for fee transparency at the record keeper level.”

The company is one of the top providers of exchange-traded funds in the country with $50 billion of assets under management and $15 billion in target-date assets.

By offering low-cost plans without a minimum, it will benefit plans of every size. Most plans would need $100 million in assets to get close to that kind of offering, he says.

“We continue to see strong interest in the funds. We see that throughout the industry, with TDFs the qualified default for many plan sponsors now and in the future,” Gilliam says. “That will continue to grow. Many plan participants will select them proactively or be defaulted in as participants in a 401(k) going forward, accelerating the growth of TDFs.”

Schwab figured out that the difference between paying 73 basis points and 8 basis points in fees was about $160,000 in additional retirement savings.

The underlying assets in Schwab Target Index Funds are primarily Schwab’s market-cap index ETFs, each of which has the lowest operating expenses in its respective Lipper category, the company said in a release.

“The impact of keeping expenses down is enormous, especially for products designed to be held over a long period of time,” the company said.

Schwab also lowered the fees on its Schwab Bank Collective Trust Index TDFs for 401(k) plans. The Schwab Indexed Retirement Trust Funds offer passive, index-based strategies. As of Nov. 1, 2016, plan sponsors will be able to access these funds for 8 basis points and no minimum investment required. Schwab Bank also offers the Schwab Managed Retirement Trust Funds that blend active and passive sub-advised strategies.

Schwab’s Target Index Funds start out with 95% equities and 5% fixed income, cash or cash equivalents. At their target retirement date, each fund reaches about 40% equity and 60% fixed income, cash or cash equivalents. Each fund then continues to reduce its equity allocation for an additional 20 years to reach its most conservative and final allocation of 25% equity, 75% fixed income, cash and cash equivalents.

“Our new Schwab Target Index Funds provide automatic diversification and ongoing professional management at remarkably low prices,” Gilliam says. “Coupled with our long track record, we believe these new funds will have strong appeal to employers, retirement plan participants and individual investors.”

Surz adds that he believes what Schwab is doing is a “gamble in attracting a certain amount of assets. If they don’t get that asset level, they will fold it up.”

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