DC Plan Investment Menu Evolution Continues

NEPC has published its annual “Defined Contribution Plan Trends and Fee Survey” results, compiling the responses of nearly 140 DC retirement plans with $230 billion in aggregate assets owned by some 1.6 million participants. The average plan in the sample includes $1.7 billion in assets, while the median holds $728 million.

According to the analysis, retirement wealth has risen tremendously over the past five years, such that the growth of plan assets may offer fiduciaries the opportunity to consider different vehicle structures or investment solutions—namely collective investment trusts, separate accounts and custom solutions.

The NEPC survey shows that, at least in the large-plan market segment, target-date funds continue to be the go-to default investment selection. A whopping 97% of plans in the sample offer a TDF, with 95% using the option as the plan default. The continued growth of plan assets in TDFs is, in this sense, reducing the importance of the core menu, NEPC says.

According to NEPC, one of the most prominent trends identified in the past year is a move toward index-style funds, with 38% of plans now offering index-based TDFs. At the same time, 70% of plans offer a “tier” of three or more index funds in the core menu. The median percentage of plan assets invested in core menu index funds is 15%.

Beyond the indexing trend, the survey results suggest guaranteed retirement income solutions and environmental, social and governance-themed investments will slowly but surely progress in 2022. Nearly all plans in the sample offer the makings of a “retirement tier,” but many continue to lack an option providing guaranteed lifetime income. Meanwhile, NEPC says many active managers are starting to consider ESG approaches.

Other investment menu trends identified in the research include the following:

• 66% of plans offer stable value, while 53% offer money market;
• 32% of plans offer Treasury inflation-protected securities, but take-up is low, indicating that TIPS’ role in protecting purchasing power for participants drawing an income may be misunderstood, given their price volatility;
• 12% of plans offer high-yield fixed income;
• 11% of plans offer real estate investments; and
• 24% of plans offer a dedicated emerging markets option.

Discussing the research results with PLANADVISER, Bill Ryan, partner at NEPC and head of DC solutions, says one perhaps surprising finding identified in this year’s survey is that the rate of adoption of managed accounts has remained flat for the past three years. Specifically, back in 2019, 37% of plans in the survey offered some type of managed account. This figure actually fell to 36% in 2020 before climbing again to 38% as of the end of 2021.

“This is somewhat counter to expectations, given the strong marketing promotion by recordkeepers,” Ryan observes. He says this dynamic is a bit puzzling on first blush because, overall, when offered at a reasonable fee level, managed accounts can be a useful solution to help participants meet individualized objectives.

In fact, in Ryan’s view, it is likely that technology developments and platform investments by recordkeepers will reverse this dynamic, mainly by bringing the price of managed accounts closer in line with those of target-date funds.

“We are seeing tremendous levels of investment by the top recordkeepers in the types of technology and back-end systems that should make managed accounts far cheaper and scalable,” Ryan observes. “Similar to the way prices have fallen substantially in the TDF market, I think we can expect prices on managed accounts to fall dramatically in the near- to mid-term future—say over the next three to five years, if not sooner.”

Ryan says leading recordkeepers are also investing heavily in the types of systems and solutions that should allow them to help address their retirement plan clients’ more immediate financial needs. For example, more recordkeepers are building out capabilities that will allow them to support their clients as they pay down student loan debt or as they save for short- and long-term health care expenses via tax-advantaged health savings accounts.

The other important trend Ryan points to involves the use of custom investment solutions by large retirement plans. For some time now, he says, the assumption in the marketplace has been that large plans choose to use custom investment solutions in order to give their participants access to novel investment types—perhaps private placements or special types of real estate. While this has been a trend, Ryan says, increasingly, the use of custom investment solutions by large DC plans is taking on a bit of a different character.

“Increasingly, the use of custom investments is actually a new strategy being implemented to address what we can call ‘managed concentration risk,’” Ryan says.

He explains the idea is that if a plan with, say, $5 billion in assets has a big chunk of that invested in a large-cap U.S. equity fund, this means the plan is going to have a very large sum of money, perhaps on the scale of a $1 billion or $2 billion, with a single investment manager. Using custom funds allows the plan sponsor to allocate large-cap U.S. investments across two or three managers, which in turn reduces the risk that an unexpected problem with a single investment manager will cause a huge amount of disruption for the plan.

“With this approach, if a manager change has to happen, it does not require liquidating the entire holding, but only a portion,” Ryan explains. “I think this is a strategy that we can expect to become very popular among the largest DC plans.”