DC Plans Slowly Close Pension Performance Advantage

Data collected by CEM Benchmarking from close to 2,000 defined benefit (DB) pension funds and over 1,600 defined contribution (DC) plans over the last 10 years suggests DB plans outperformed DC plans after fees by only 0.46%.

As researchers note, this is “a massive improvement” from the previous comparison reviewing the 1998 to 2005 time period, where the net return difference was 1.8%. According to the independent provider of cost and performance analysis for pension funds, DC plans, sovereign wealth funds and other large institutional investors, “this is simply great news for DC plan participants.”

“Our first study was all doom and gloom,” observes Sandy Halim, lead author of the study at CEM Benchmarking. “The warning message was, in 25 years, DC account value would be 34% smaller than DB plans if they both started with the same dollar amount. Thankfully, our updated research shows that’s no longer the case since plan sponsors made substantial improvements to their plans during the past 11 years. This translates to a much smaller 12% difference in account balance over 25 years.”

The first source for the improved DC plan performance, Halim says, is a significantly improved asset mix. In 1998, company stock, stable value and cash represented 44% of all of DC plans’ holdings, whereas by 2016, these holdings had decreased to 25%.

“The assets have mainly moved to target-date funds and balanced funds,” Halim confirms. “In 1998, 15% of assets were in target-date funds and balanced funds, compared to 26% by 2016. Target-date funds, in particular, have exploded in popularity. In 2007, 46% of plans in our DC database offered a target-date fund, compared to 87% in 2016.”

And the asset mix is not the only plan design element to show massive improvements, CEM researchers find. There is clear evidence of much greater use of automatic enrollment, and greater use of a sensible default options as qualified default investment alternatives. Beyond this, Halim says, there were “many lessons learned from behavioral economics” in the early 2000’s that are now paying real dividends. Some of the most impressive gains include the following: 

• Automatic enrollment in primary retirement plan now in place for 80% of all sponsors surveyed, up from 62% in 2007. Additionally, 70% of supplemental plans featured auto-enrollment in 2016, up from 51% in 2007.
• Fully 95% of plans now have a default option, up from 79% in 2007.
• As of 2016, 84% of sponsors have a target-date fund as their default option, up from 30% in 2007.
• The biggest asset mix improvement has been realized within DC plans that no longer used a GIC/stable value/cash investment option as their default option. This represents just 1% of plans in 2016, down from 21% in 2007.

“Many plan sponsors took these lessons to heart and made plan design changes that resulted in higher participation and a better DC asset mix,” Halim adds.

Since the last study, average DB fund costs have increased from 0.40% to 0.60%, whereas DC plan costs have remained constant at 0.39%. This cost saving of 0.21% has also contributed to the lower net return difference, Halim says.

“DB plan costs have increased because DB plans are embracing more, higher cost, alternative assets (23% in 2016 for combined policy weight in real assets, private equity and hedge funds up from 14% in 2007),” the research shows. “DC plan costs have remained the same despite their improved asset mix, as they have also embraced low cost indexed options (58% of the indexable assets were in passive options in 2016, up from 40% in 1998).”

The full white paper is available for download here.