DCIO State of the Industry

Assets in defined contribution plans keep growing, but so does the scramble for relevant investment solutions as plan sponsors remain focused on low fees.

The defined contribution asset pool keeps growing, hitting a record $11.3 trillion after the first half of 2024 on 730,000 plans and 85 million active participants, according to data from Brightscope, which, like PLANADVISER, is owned by ISS STOXX.

While Baby Boomers will no doubt be drawing down funds for retirement in the coming years, that growth may continue as new plans are predicted to come online at rapid rates as a result of both state mandates and federal incentives.

Despite this growth, there are many challenges ahead for the defined contribution investment only industry. Fee compression and the related litigation, along with the success of automatic, ‘set it and forget’ savings, has led to a shrinking pool of providers with fewer levers to produce revenue.

How, then, will the DCIO industry continue to evolve in a sustainable way? In our State of the Industry round-up, we speak with DCIO providers and consultants about some of today’s opportunities and challenges.

TDFs Grow, Evolve

The DCIO industry has been, in some ways, a victim of its own success in making relatively low-cost target-date funds as qualified default investment alternatives. TDFs’ decades-long popularity shows no signs of slowing down, having surpassed $3.5 trillion in assets this year, an all-time high, says Michael Cagnina, senior vice president and managing director for SEI Investments Co.’s institutional business.

“This growth underscores their appeal, especially given that many plan participants lack the time or expertise to navigate complex investment options,” says Cagnina via email.

Bill Ryan, a partner in and the defined contribution team leader at NEPC LLC, agrees that the firm is continuing to see “heavy cash flow” into target-date funds for all ages—including those older than 65 who are keeping their investments in-plan for longer.

“We’re going to continue to see target-date funds take market share away from the core lineup in the next 12 to 18 months,” Ryan says.

The makeup of TDFs is not sitting still, he notes. Some providers are creating more aggressive glide paths for investors younger than 65 so they do not fear losing out on growth.

The Active and Passive Dance

Kerry Bandow, the head of defined contribution solutions for Russell Investments, notes that while passive investment strategies continue to dominate large plan sponsor thinking, some large plan sponsors are bringing in active TDF strategies.

“I’m not sure if I would call it a trend yet, but we are seeing more committees considering the inclusion of at least some active management in their target-date funds,” he says. “This decision has been supported quantitatively, where we are projecting better participant outcomes when active management is included, but also by committee beliefs reflected in their past decision to include active strategies in their [defined benefit] portfolios.”

Meanwhile, NEPC’s Ryan says, his team has been interested to see some of the largest passive fund managers coming to market with competitively priced active funds. He believes these offerings will pull money away from the traditional active managers to those large passive fund managers to the tune of some $8 billion in the next 18 months. While that may be small compared to the $3 trillion in actively managed funds, it could seriously shift the market for active funds over the long term.

“I think with the passive providers being able to offer more moderate to aggressive off-the-shelf products, that puts a lot of pressure on the active managers in the space, as, historically, they were the only ones out there [with such offerings],” he says. “If you like a higher-risk posture but at a low-cost entry point, you now have a choice.”

The challenge for active managers working with large caps, Ryan notes, is the dominance of the Magnificent 7 tech stocks of late, because active managers may have restrictions on what percent of investments can be held in a single or group of stocks. Even if that is only causing relatively short-term underperformance, it could trigger plan fiduciary monitoring for the funds to be reviewed or replaced.

Diversifying Asset Classes, Managers

On August 5, the markets took a dive, in part due to a U.S. labor market report that spooked investors. While markets have seen a strong return since then, Cagnina still expects volatility in coming months due to interest rates changes, the U.S. presidential election and labor market uncertainty, which means diversified asset classes will be more popular.

He notes that SEI will continue to advocate for diversification, including investments in areas such as liquid credit, inflation hedging, real estate and low-volatility equities.

“This approach is designed to enhance portfolio resilience and optimize long-term returns in an increasingly uncertain market environment,” Cagnina says.

Idin Eftekhari, a senior retirement analyst with Cerulli Associates, says one DCIO trend is diversifying into alternative investments. While that has long been a defined contribution push, popularity across retail investing may bring it closer to reality—though Eftekhari notes an ongoing analysis of which types of alternatives will work best.

“Specifically, we are monitoring which asset classes—such as private real estate, private equity, private credit and infrastructure—will gain in popularity,” he says.

Russell’s Bandow notes that “there continues to be limited utilization of alternative investments” among DC sponsors. Firm representatives have talked with committees about managing for inflation through diversification, but “most often, we would advocate for consideration of a diversified real asset fund that invests in assets such as commodities, [Treasury inflation-protected securities], [real estate investment trusts] and listed infrastructure.”

Separately, more plan sponsors of all sizes are considering diversification to a multi-managed portfolio instead of a single manager, Bandow notes.

“Most investment committees for large defined contribution plans have embraced this structure for years, but plans of all sizes are now evaluating this as an alternative to single-manager portfolios,” says Bandow. “Part of the rationale for this interest is that managers focus on different areas of the market, and diversifying among managers within one solution can provide a smoother ride for plan participants.”

Personalization Needs Meet MA Lawsuits

Another important DCIO area is further product personalization, according to interviewees.

“Participants need help with investment decisions, and we are hearing increased interest in advice solutions that can lead to more personalized portfolios,” says Tony Fiore, PGIM Investments’ senior vice president and defined contributions solutions national sales manager.

That personalization, according to the experts, is coming by way of managed accounts with advice offerings and more personalization of TDFs themselves.

But Ryan of NEPC notes that recent 401(k) litigation has resulted in “unfortunate press” that may crimp managed account uptake. Ryan notes recent complaints responding to managed account use by providers TIAA and Morningstar and engineering and construction company plan sponsor Brechtel.

The strain has been taking its toll on clients, he says, with a handful of NEPC clients “voting to terminate managed accounts” from their plans, representing “in the neighborhood of $3 billion.”

Ryan, whose NEPC has, in the past, been critical of the fees charged for managed accounts, says there will likely be further pullback from offering the personalized savings vehicles to investors, in part because of further litigation that may drop.

CITs Continue March

Collective investment trusts have been chasing mutual funds as a popular investment vehicle for DC plans in recent years, with the data crunchers at Morningstar recently reporting that CIT TDF assets surpassed mutual fund TDF assets for the first time, as of the end of June 2024.

Cagnina of SEI sees that growth likely to continue.

“While mutual funds remain the dominant investment vehicle, collective investment trusts are rapidly closing the gap,” he says. “SEI views this as a positive trend, highlighting the value of simplified, professionally managed solutions in driving better retirement outcomes. Additionally, governance and fees play a critical role, with plan sponsors increasingly scrutinizing these aspects to ensure that participants are receiving value for their investments.”

PGIM’s Fiore agrees, noting as well that “we expect this trend to accelerate with potential legislation on the horizon that would allow 403(b) plans to offer CITs.”

The retirement industry has been pushing for such legislation ever since the idea did not make it into the SECURE ACT 2.0 of 2022.

CITs’ inclusion in nonprofit plans would “have a very significant impact on 403(b) plans,” says Angela Montez, the chief legal, corporate and government affairs officer at MissionSquare Retirement. “The participants don’t have access to these low-cost investment vehicles. … This would provide lower-cost, more flexible options and parity with their governmental and ERISA plan peers.”

Montez says the infrastructure and distribution networks for CIT investment vehicles are in place to allow relatively fast implementation in the 403(b) market.

“This will allow hospital workers, teachers and other nonprofit workers to build the same type of security that corporate and government workers have been enjoying for a number of decades,” Montez says, adding that legislators could include the change in a larger bill that will pass before the end of 2024.

Stable Value Back in Vogue

Finally, Ryan of NEPC notes that in the next six to 18 months, “we are going to be in a very different interest rate environment,” with the Federal Reserve likely to move rates lower.

NEPC predicts that new market environment will bring back interest in stable value funds, which had been displaced by safer investments, such as money market funds, that could guarantee strong returns on the back of high interest rates. As rates fall, stable value “is going to pop,” Ryan forecasts.

“Stable value has a structural advantage and likely has weathered the storm of higher interest rates,” he says.

—Alex Ortolani