Open Architecture and Custom Investing Trends

Custom solution assets have more than doubled since 2010 and show little sign of slowing, according to recent research from Cerulli Associates. A report from the firm, “Institutional Custom Solutions 2015: The Drive Towards Objectives-Based Solutions,” suggests investment services “devised to meet specific institutional client objectives” will grow by more than $1 trillion over the next five years to hit the $3 trillion target.

The classic example of going custom in the retirement space is working with an asset manager to build a unique target-date fund (TDF) glide path designed for a specific retirement plan client. An adviser or consultant will often be called in to help work on the asset allocation, manager selection and other components, especially how to price, track and report the fund.

Alexi Maravel, an associate director at Cerulli, says custom solutions “have the potential to upend decades-old practices of asset managers and investment consultants in assisting institutional investors in meeting their goals.”

It’s a sentiment shared often with PLANADVISER. On the defined benefit (DB) side, pension plan sponsors are focused on using liability driven investing (LDI) principles that go beyond maximizing returns and aim at reducing specific risks and overall volatility in the plan’s funded status. For defined contribution plans (DC), much of the focus is on use of custom target-date funds (TDFs), with upwards of one in three plan sponsors using or considering TDFs that strive to better match the investment approach with the needs of a given plan population, according to the SEI Defined Contribution Research Panel.

In a recent conversation, Jake Gilliam, managing director and senior portfolio manager at Charles Schwab Investment Management, noted his firm takes a different stance. He agrees the market “is really starting to recognize the importance of getting more sophisticated in the investment construction process,” but not all plan sponsors have an interest in creating and tracking custom portfolios.

“When you go custom you have to start from scratch,” he says. A less work-intensive alternative for sponsors is to consider an open-architecture investment approach, which does not involve a custom glide path. Open architecture funds come with a prepackaged and centrally managed glide path, Gilliam explains, but they add value by looking across investment providers to pick best-of-class funds when building out the underlying investment allocations. 

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“What we are seeing is plan sponsors looking at open architecture and deciding to move that way, because it is easier for the plan sponsor,” Gilliam adds. “Where you see custom being more prevalent is in the mega-plan market. In my experience, most plans out there don’t want to take on the custom tasks on a daily basis.”

Gilliam points to a variety of causes driving greater consideration of open architecture portfolios. One main cause, he feels, is the Department of Labor’s (DOL) advisory publication that actively encourages plan sponsors to look deeper under the hood of their investment solutions. Beyond this, plan sponsors are taking seriously their fiduciary duty and the related obligation to explore ways to save on investment fees and to improve performance.

“Something else is that these subjects have continued to get a lot of press in the industry media resources, and I think that’s a great thing,” Gilliam says. 

Maravel says these tailwinds are also benefiting custom investment providers, leading to optimism about their growth prospects.

“It’s not surprising that firms overseeing custom solutions assets today are so bullish about the future,” he explains. “Respondents to Cerull’s proprietary survey reported more than 58% growth in custom solutions client assets during the past year, as well as the winning of an average of 13.4 solutions mandates during the same time period.”

Gilliam stresses that open architecture and custom investing have key differences, but clearly advisers are benefiting from business engagements on both ends.

“Advisers can sell their strong selection and due-diligence process,” Gilliam explains. “Overwhelmingly, they are hearing our message and they are identifying with it, and they are taking the DOL’s guidance seriously.”