Embrace of Passive Funds Is Not What It Appears To Be

As the head of investments for Wells Fargo Institutional Retirement and Trust, Jeff Kletti works closely with Joe Ready, executive vice president and director of Wells Fargo Institutional Retirement and Trust—and a familiar name to readers of PLANADVISER.

Although his purview extends beyond the defined contribution (DC) plan industry, working with Ready, this is a big part of Kletti’s day-to-day work. As such, he was recently called on to help lead a large-scale analysis looking into trends, challenges and opportunities emerging in the firm’s large 401(k) book of business.

“There were some clear insights to emerge in the DC business,” he says. “In particular, 2017 saw active managers come somewhat back into favor after three years of trailing passive flows. Even so, when we looked across our book, we saw that in general, plan sponsors in the last few years have increased the number of standalone index options in their core menus.”

The offering of standalone index investment options roughly doubled, Kletti says, from two to four options, in the large-client segment of the book. Among mid-sized plans and smaller employers, the trend was somewhat more muted but still clearly visible. 

“And it has been about adding more than just the S&P 500,” Kletti notes. “We’re seeing increased popularity in offering passive international equity, small cap passive, and passive core bond.”

Tepid interest among participants

Importantly, looking at the asset flow data provided by Wells Fargo, there is in fact very little money going into these standalone funds that are being added. Kletti says a number of factors are behind this—first that the investment lineup changes have been additions to plan menus, rather than replacement-reroutes, or “mappings,” as the DC industry parlance goes.

“That approach, of actively mapping participants out of active options into passive options, is still rare on our platform at this stage,” Kletti confirms. “So, the point is, that these active-versus-passive trends are playing out with more subtlety than it might first appear. Virtually all of the ongoing flows into passive funds in our book of business have been coming from within the target-date fund context, not from stand-alone index funds. Within TDFs, that is where the massive shift in active to passive has in fact taken place.”

Again, Kletti points to “a whole confluence of factors” driving the interest in passive target-date funds.   

“Of course a lot of it has to do with the Department of Labor (DOL) fiduciary rule change,” he muses. “And there is just so much concern about overall fees in general, this is pushing more plans to use passive qualified default investment alternatives. Another big part of this has been the performance of the markets in recent years. It has been much easier for plans to make this move towards passive-based defaults, given the performance of index target-date funds.”

In the Wells Fargo book of business, target-date fund (TDFs) assets as a percentage of overall plan assets have now reached 30%. And when selecting specifically for passive options, in just the last three years, the data shows there has been a 30% increase in the number of Wells Fargo-serviced plans now offering a passive target-date fund. Underneath of this, the assets in passive TDFs have doubled.

CITs and passive go together

Turning to his work in the collective investment trust (CIT) space, Kletti points to a very similar ongoing conversation. CITs are increasingly being viewed by plan sponsors as delivering lower fees for the same strategies, he explains.

“We’re also seeing, whether it’s a CIT that we offer or whether it’s a CIT that sponsors are using from an outside manager, the minimum investments needed to enter these collectives are coming down very significantly,” Kletti notes. “That has helped to make CITs to be a hot topic in 2018—they are becoming very much more accessible in the mid-market and the small-plan market as well.”

He says Wells Fargo has found plan sponsors greatly value the fact that, under the state-based CIT regulatory structure, the sponsor of the CIT is considered a fiduciary, “whereas this is not necessarily the case for a mutual fund.”

“There is still some bifurcation among the different market segments on the CIT topic,” Kletti concludes. “The large market is more or less comfortable with CITs already and they have been there for years. But these days, mid-sized plans in the Wells Fargo core market, those in the $50 million to $250 million space, are very quickly coming to have a deeper understanding of and interest in collective trust products.”