Managers Expect Annuity Allocations to be Incorporated Into TDFs

The strategic incorporation of lifetime income products and alternative investments in target-date funds (TDFs) could potentially help providers deliver superior long-term outcomes for plan participants and differentiate themselves in a market dominated by a handful of low-cost providers, according to the December issue of “Cerulli Edge—U.S. Asset and Wealth Management Edition.”

Momentum for including income products in TDFs has been building since 2014, when the IRS issued guidance providing that plan sponsors can include deferred income annuities in TDFs used as qualified default investment alternatives (QDIAs) in a manner that complies with plan qualification rules. A significant barrier to plan sponsor adoption of guaranteed income features was addressed by the Setting Every Community Up for Retirement Enhancement (SECURE) Act, which—along with a provision addressing the portability problem with annuity products—offered a fiduciary safe harbor for the selection of guaranteed income providers.

According to Cerulli’s report, the majority (92%) of TDF managers said they expect managed payout options and annuity allocations will be incorporated into future TDF series. The market volatility of the first quarter of this year may also serve as a catalyst for guaranteed income adoption by defined contribution (DC) plans, as nearly two-thirds (63%) of TDF managers suggest this period of heightened market volatility will increase client demand for guaranteed investments.

Cerulli notes that market downturns can help illustrate annuities’ downside protection benefits.

Private Equity

Cerulli says it expects that in the coming months, plan sponsors and retirement plan providers will engage in more detailed exploratory discussions regarding the inclusion of private equity in multi-asset-class products such as TDFs. The Department of Labor (DOL) released an information letter earlier this year offering regulatory guidance related to the use of private equity funds within professionally managed strategies (e.g., TDFs, target-risk funds) that may serve as a DC plan’s QDIA.

Cerulli says it is perhaps most critical for providers to clearly demonstrate to plan fiduciaries how allocating to a certain private equity strategy within a professionally managed product can improve long-term outcomes for plan participants on a risk-adjusted, net-of-fees basis. However, private equity investments come with challenges that plan sponsors need to be made aware of.

“Private equity funds are typically characterized by infrequent pricing events, low liquidity, relatively high management fees and complex investment structures. Conversely, the DC market—litigious in nature—is notoriously fee-sensitive, and the product landscape is dominated by simple, transparent, low-cost investment vehicles,” says Cerulli Senior Analyst Shawn O’Brien. “It may take time for many plan fiduciaries to gain a sense of comfort with private equity investments, and, therefore, thorough educational and informational engagements may be a necessary precursor to adoption in a DC market where private market investments are rare.”