Passive target date funds (TDFs) grew to a trillion-dollar-plus market on the strength of two big ideas: that investors pay the lowest possible fee; and that asset values increase when interest rates are low. This was never a realistic promise in the fixed income arena. And then interest rates shot up.

Dan Oldroyd, Portfolio Manager and Head of Target Date Strategies at J.P. Morgan, explains why it’s time for consultants, advisors and plan sponsors to re-underwrite default decisions in 401k and defined contribution plans. 

How do you view the passive TDF market?

These funds have always been marketed as a way for investors to achieve reasonable outcomes in retirement accounts at the lowest possible fee. But the underlying investment strategy is not what most people assume it is. That is, it’s not truly passive. Plus, in the now-higher interest rate environment, thoughtful active managers have new opportunities to generate excess returns, which passive funds may be missing.

Why the need for action now?

Consultants, advisors and plan sponsors generally re-underwrite fund selections every three to five years. A lot of players went passive in fixed income one, two, three, four, five, or six years ago. Given that interest rates are likely to remain high for the foreseeable future, now is a good time to re-evaluate the funds in clients’ retirement accounts. If further incentive is needed: In this same time period, active fixed income managers added a lot of value – and passive TDF investors left money on the table. 

What makes passive target date funds less optimal?

In the passive equity arena, managers can buy an entire index. That’s how you know you’re going to get the performance of the index.

That’s not possible in fixed income, where even bonds from a single issuer can have different tenors, different terms, different yields. As a result, managers use sampling to get the best approximation of the index; for example, holding 8,000 or 10,000 of the 14,000 names in the Bloomberg Aggregate Bond Index.

Also keep in mind: An equity manager buying the S&P 500 is getting an index weighted by how much companies are growing. Passive fixed income funds are weighted to companies issuing the most debt. How many investors would knowingly want to lend money to companies with the most debt?

Are passive TDFs really passively managed?

No! “Passive” here refers to the underlying strategies managers invest in to keep fees low; typically, low cost index funds. However, when it comes to asset class diversification, glide path design, investment strategy selection and portfolio construction, all TDFs are actively managed strategies.

Does this heighten diversification risk?

As noted above, to keep fees lows, TDFs typically shun asset classes that are more difficult or expensive to replicate, such as high yield bonds and real estate—even though, historically, these assets have been extremely additive to long-term performance. 

Where do you see opportunity?

In active management. There’s an inherent opportunity for asset managers who are skilled and well-resourced to generate excess returns by developing an information advantage.

For example, at J.P. Morgan, we’ve been able to consistently generate 30 to 40 basis points of excess returns, net of fees, in our Core Bond and Core Plus funds. 

What’s your advice for fund managers?

The market prioritizes low fees and “safe outcomes” – a strategy that, in part, aims to protect fund managers from being sued. But what investors more typically get is the lowest fee and a lot of active management, with all of the attendant opportunities and risks.

My advice to fund managers and fiduciaries: Focus on the value of a fund’s approach and don’t discount risk management and outcomes. It will be a more productive starting point than searching for the lowest fee.

Mutual funds have fees that reduce their performance; indexes do not. You cannot invest directly in an index.

Investing involves risk, including possible loss of principal. Investment returns and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than their original cost. Brokerage commissions will reduce returns.

Actively managed funds typically charge more than index-linked products. Asset allocation/diversification does not guarantee investment returns and does not eliminate the risk of loss.

Core Bond Fund & Core Plus Bond Fund Risk Summary: Risk Summary

Investments in bonds and other debt securities will change in value based on changes in interest rates. If rates rise, the value of these investments generally drops.

The value of investments in mortgage-related and asset-backed securities will be influenced by the factors affecting the housing market and the assets underlying such securities. The securities may decline in value, face valuation difficulties, become more volatile and/or become illiquid. They are also subject to prepayment risk, which occurs when mortgage holders refinance or otherwise repay their loans sooner than expected, creating an early return of principal to holders of the loans.

The Fund could experience a loss and its liquidity may be negatively impacted when selling securities to meet redemption requests by shareholders. The risk of loss increases if the redemption requests are unusually large or frequent or occur in times of overall market turmoil or declining prices. Similarly, large purchases of Fund shares may adversely affect the Fund’s performance to the extent that the Fund is delayed in investing new cash and is required to maintain a larger cash position than it ordinarily would.

Additional Risk Disclosures for Core Plus Bond Fund: CMOs are collateralized mortgage obligations, which are issued in multiple classes, and each class may have its own interest rate and/or final payment date. A class with an earlier final payment date may have certain preferences in receiving principal payments or earning interest. As a result, the value of some classes may be more volatile and may be subject to higher risk of nonpayment.

Securities rated below investment grade are considered “high-yield,” “non-investment grade,” “below investment-grade,” or “junk bonds.” They generally are rated in the fifth or lower rating categories of Standard & Poor’s and Moody’s Investors Service. Although they can provide higher yields than higher rated securities, they can carry greater risk

Target Date Funds: The JPMorgan SmartRetirement Funds are target date funds with the target date being the approximate date when investors plan to retire. Generally, the asset allocation of each Fund will change on an annual basis with the asset allocation becoming more conservative as the Fund nears the target retirement date. The principal value of the Fund(s) is not guaranteed at any time, including at the target date. Conflicts of Interest: Refer to the Conflicts of Interest section of the Fund’s Prospectus.

09js242506204353