Are Managed Accounts Better for Participants Than TDFs?

The percentage of defined contribution (DC) plans offering in-plan professional investment assistance has grown significantly over the past decade, according to data from Alight Solutions.

In 2005, 6% of plans offered managed accounts and 33% of plans offered target-date funds (TDFs), compared to 58% and 93% of plans in 2017, respectively.

Alight Solutions analyzed the 10-year time period from January 1, 2007, through January 1, 2017, of data from nearly 50 companies that offer TDFs and managed accounts covering more than 2 million eligible participants as of January 1, 2017, and found among all plans 7% of participants were managed account users—workers enrolled in a managed account service at any point in time during a year—and 38% were full TDF users—workers whose in-plan assets were at least 95% invested in one or more TDFs at the end of a year. Among plans that offer both managed accounts and TDFs, 12% were managed account users and 42% were full TDF users.

Younger workers are most likely to be full TDF users. More than half of participants younger than 30 are full TDF users. At the other end of the continuum, older workers are more likely to be non-users. In every age cohort older than 40, the majority of workers are non-users. And although the popularity of managed accounts grows as age increases, it never exceeds 20% of the participants in any age cohort.

While the growth of automatic enrollment contributes partially to this trend, Alight says age remains an important factor even when controlling for the impact of automatic enrollment. For example, among those not subject to automatic enrollment, 45% of participants younger than 40 are full TDF users versus only 25% of participants age 40 or older.

The analysis found that participants who use managed accounts are much more likely to stay in them than full TDF users. Among workers who were enrolled in a managed account during 2007 and are still active in the plan, just over one-quarter (26%) exited their managed account prior to 2017. In contrast, two-thirds (67%) of fully invested TDF users in 2007 were no longer fully invested in TDFs by 2017.

When workers change from full TDF usage, older workers tend to increase equity concentration, while younger workers tend to decrease equity concentration. According to Alight, this implies that workers who choose to opt out of using the TDF as their sole investment may have different risk preferences or may be factoring in other retirement assets when setting their equity allocation. However, it also could show that many participants who invest on their own may not have the acumen to appropriately diversify based on their age, risk preference, and other investments.

Managed account users see better returns

Over the past 10 years, managed account users have performed better on average than full TDF users and non-users, Alight found. Managed account users have earned higher average returns in five out of the last 10 years, while full TDF users have earned higher average returns in just two out of the last 10 years. In the remaining three years, non-users earned the highest average returns.

Consistent managed account users had an average annualized 10-year return net of fees that was 0.27% higher than that of consistent non-users, and consistent full TDF users had an average annualized 10-year return that was 0.26% higher than that of consistent non-users.

Twenty-five percent of consistent non-users earned a 10-year annualized rate of return that was 2% or less. In contrast, just 4% of consistent managed account users and 3% of consistent full TDF users earned an annualized return of 2% or less over the same 10-year period. The seventy-fifth percentile for the 10-year annualized rate of return for consistent non-users was 5.80% compared to 4.04% for consistent managed account users and 4.31% for consistent full TDF users.

However, over the past five years, TDFs have lagged. Workers who consistently used managed accounts over a five-year period earned an average annualized return that was 1.15% higher than that of the consistent TDF users. Ninety percent of consistent managed account users earned an annualized 10-year return between 2.10% and 4.76%, while 90% of consistent non-users earned an annualized 10-year return between −4.74% and 9.15%.

Among near-retirees, professional investment assistance has been particularly beneficial, Alight found. Consistent managed account users had an average annualized 10-year rate of return that was 0.69% higher than the average annualized 10-year rate return for consistent non-users (3.43% versus 2.74%), and consistent full TDF users had an average annualized 10-year rate of return that was 0.89% higher than consistent non-users (3.63% versus 2.74%).

In addition, the range of returns for consistent users of professional investment assistance was fairly narrow. Among the near-retirees, consistent non-users had an extremely wide range of returns—in fact, they had the widest range among all age cohorts in the analysis. Twenty percent of near-retirees who did not consistently use professional investment assistance earned a 10-year annualized rate of return below 0%. In contrast, just 2% of consistent managed account users and 1% of consistent full TDF users earned a negative rate of return during the same period.

Managed account users more diversified and save more

Managed account users have investment portfolios that are much different from those who go it alone. Non-users invest more in stable value funds and less in bond funds. Among workers older than 55, the average allocation to bonds is 20% for managed account users, compared to 10% for non-users.

Non-users invest less in international equities. The average allocation to international equities among managed account users is 24%, compared to only 6% for non-users. Managed account users invest less in employer stock when company stock is offered as a plan investment option. Among companies that offer employer stock as an in-plan investment option, non-users invest, on average, 18% of their balance in employer stock. Managed account users have an average of 2% of their balance in employer stock.

The analysis also found workers who consistently use managed accounts more consistently make contributions to the plan. The average contribution rate for managed account users is 8.5%, the same as for non-users of either managed accounts or TDFs, while the average contribution rate for full TDF users is 6.1%. Alight says this is a result of many using plan defaults that generally have lower average savings rates than the ones seen among actively enrolled participants.

Contributing to the plan consistently leads to more savings for participants and improves retirement readiness. Over the last three-year and five-year periods, consistent managed account users continuously participated at a much higher rate than consistent full TDF users and non-users. Three out of four (75%) consistent managed account users continuously made contributions over a five-year horizon, compared to 61% of full TDF users and 43% of non-users.

The problem with TDFs

Alight found most participants who use TDFs do not fully invest in them. More than half of workers who use a TDF also have a portion of their balance invested in other funds.

At the root of this problem is the fact that most workers do not understand TDFs.Only 11% of surveyed workers knew that TDFs are designed so they need to invest in only one fund instead of several funds. When presented with five true-or-false questions about TDFs (e.g., “A TDF rebalances over time.”), only 2% of surveyed workers could correctly answer all five questions. More than 60% readily admitted that they didn’t know anything about TDFs

Suggestions for DC plan sponsors

Armed with this information, Alight suggests that DC plan sponsors include professional investment advice solutions in their plans and even re-consider the default investment option.

The firm also suggests plan sponsors communicate more extensively about the professional investment advice solutions offered by the plan, and raise understanding of how to best utilize these tools. It suggests DC plan sponsors should have in-person seminars that explain professional investment assistance services.

The full study report, “The impact of managed accounts and target-date funds in defined contribution plans,” may be downloaded from here.