Up in the Air

Art by David Jien

The defined contribution investment only (DCIO) market is a formidable force, holding $3.5 trillion, or 48%, of the assets in defined contribution (DC) plans, according to Sway Research. These assets are expected to grow 26% to $4.4 trillion by 2020, at which point DCIO firms will hold 52% of all DC plan assets.

Nonetheless, despite this bullish outlook, DCIO firms—and DCIO groups, at the more traditional recordkeepers—are facing challenges and undergoing change, according to researchers and executives at these firms. “Fifteen years ago, when plan sponsors started to move to assets unbundled from recordkeepers, DCIO providers really saw an uptick in assets,” says Brian Donoghue, a partner with NEPC in Boston. “Today, the growth in assets for these providers has really flattened. That suggests a mature market.”

Market Shakeout
In addition, “a disproportionate amount of assets is going to a finite few DCIO providers,” says Mike De Feo, managing director at Voya Investment Management in New York City. “We think there will be an event that occurs at a firm or in the marketplace that will highlight the concentration of these assets, and intermediaries will look for alternatives” to the market leaders.

It has become necessary for DCIO firms to ensure that their products are approved by such “shadow fiduciaries” as Morningstar and Mercer, which vet funds, so that advisers will select them for the retirement plans they serve, says Gene Huxhold, senior managing director, investment only retirement plans, at John Hancock Financial Services in Chicago. These companies “dramatically influence what investments an adviser can offer in a plan, so it is important for us to know what they are doing and that they are looking at our better products.”

Likewise, because of the pending fiduciary rule “and potential liabilities, major wirehouses and broker/dealers [B/Ds] are putting guardrails on what funds their retirement plan advisers can select, so I need to make sure John Hancock is on that list as well,” Huxhold says.

The Move to Unbundled TDFs
Recordkeepers, such as Fidelity Investments, Vanguard and T. Rowe Price, that offer proprietary investments were the first to launch target-date funds (TDFs), and, as a result, they command more TDF assets than do TDFs managed by DCIO providers, Huxhold says.

However, “one of the most important developments for DCIO providers is the shift away from the first generation of TDFs manufactured by recordkeepers,” says Bing Waldert, an analyst with Cerulli’s retirement team in Boston. Advisers and sponsors are increasingly interested in open-architecture target-date fund products, which will boost DCIO sales, he says.

In fact, Huxhold says, that in the last six or seven months, John Hancock has received several inquiries from sponsors about its open-architecture TDFs. “They are looking for best of breed,” he says.

DCIO providers also lead the way with innovation in TDFs, says Dan Cook, another Cerulli analyst. “Many firms are entering the waters with new and innovative products, including those that provide retirement income,” Cook says. These products could do particularly well if the fiduciary rule prompts retirees to keep their assets in their plan, he says.

BlackRock, for one, is currently discussing with its plan sponsor clients what their responsibilities will be in terms of offering investment options for retirees in their plans, says Anne Ackerley, head of BlackRock’s U.S. and Canada defined contribution business, in New York City. “Now, as the Baby Boomers are beginning to retire, along with the distinct possibility that people will remain invested in the 401(k) plan past retirement, we are having discussions about what decumulation looks like in a 401(k),” Ackerley says. “This is an emerging trend.”

Further, many sponsors are looking for custom TDFs, she adds.

Voya’s largest plan sponsors already use customized products, De Feo says. “While [the practice] hasn’t trickled down to other market segments, we do expect that will happen over time,” he says.

Shining a White Light on Fees
“The 408(b)(2) fee disclosure rules in 2011 have brought greater transparency and scrutiny to administrative and asset management fees,” says Chris Brown, founder of Sway Research, in Newton, New Hampshire.  “Now, the impending fiduciary rule has heighted this focus,” Brown continues. “This has placed greater pressure on asset management fees, which places active managers at a disadvantage to passive ones, which can manage money at a far lower cost, particularly in the large-cap domestic equity style box and target-date funds.”

The trend has made it necessary for active managers, whose products are sold at a premium price, “to demonstrate premium value,” says David Blanchett, head of retirement research at Morningstar Investment Management in Chicago.

MassMutual, which entered the DCIO market in 2015, has done just that and has enjoyed success due to the firm offering 12 top-performing funds in its lineup, says Aruna Hobbs, head of institutional investments for retirement plans at MassMutual, in Enfield, Connecticut. “Many of our funds rank within the top 15% of their peers and have been beating their benchmarks for the past five to 10 years,” she says.

While passively managed funds are currently popular among plan sponsors, Voya believes that, in light of projected lower equity and fixed-income returns, “the pendulum will shift back to why active management is a competitive alternative,” De Feo says. “We think we are entering into that market cycle now.”

Huxhold agrees with De Feo: “I think this big trend into passive is starting to wane, especially as we begin to have more volatility in the markets. This will give active managers an opportunity to distinguish themselves.”

“While many sponsors have moved into passive investments due to the pressure on fees, we did an omnibus survey of participants and found that the majority want both active and passively managed funds,” Hobbs says. “We could be doing them a disservice by focusing only on passive. There is space for both.”

Related to this, Fidelity believes DCIO providers need to offer a wide range of products that include “TDFs, passive options and quality investment solutions across classes, both active and passive,” says Jordan Burgess, head of specialist field sales at Fidelity Institutional Asset Management in Smithfield, Rhode Island. “We need to participate in all of the asset classes an adviser may consider for a plan menu.”

Adviser Services
One way DCIO providers traditionally have distinguished themselves and cemented their relationships with retirement plan advisers is by offering them value-added services, says Marc Caras, head of the retirement plan network at Pershing, in Jersey City, New Jersey. “The large DCIO firms are really focused on getting in front of the right advisers and building a relationship with them,” Caras says. “We have seen these firms host events on practice management, sales, and service solutions, to help advisers become more productive and efficient.” In partnership with Pershing, “[the firms] also increasingly offer tools for such things as rollovers and sales reporting, to help them with their business model and to home in on the right opportunities.”

In addition, some DCIO firms have been providing participant educational materials and information on retirement outcomes, Caras says. “Investments are a commodity. To differentiate themselves, these firms have been investing in such value-added services to help advisers grow and scale their business,” he says.

It has become increasingly important for DCIO providers to “[supply] a level of insight and thought leadership on the marketplace,” Burgess agrees. “Advisers and plan sponsors are looking for services beyond just investment products. We have chosen to be very focused on thought leadership. As the largest recordkeeper in the world, we can provide a tremendous level of insight into participant and plan sponsor behavior. In addition to this, through our Plan Sponsor Attitude program, we go to outside recordkeepers to gather information. This has translated into some really effective thought leadership that we can share with advisers and plan sponsors.”

Likewise, Voya has developed Retirement U for Advisors, a series of practice management courses. “It covers not just retirement but all things wealth-management-related,” DeFeo says. “We view this as the cost of entry into the market” because of advisers’ value-add expectations.

A survey that Cerulli recently conducted among retirement plan advisers confirms that they expect such services from DCIO providers, Cook says. “Advisers want help forming investment policy statements [IPSs], [and] with plan benchmarking and navigating ERISA [Employee Retirement Income Security Act] and regulations,” he says. “This is an opportunity for DCIO providers.”

The Fiduciary Rule
Finally, DCIO providers expect that the fiduciary rule will help them in several ways. Retirees’ assets are likely to remain in plans. Sponsors may be more inclined to turn to a DCIO provider as they question whether it is prudent for the recordkeeper to also be managing the assets. And advisers will look to the providers for education on how to respond to the fiduciary rule.

“The fiduciary rule will create a higher hurdle for rollovers,” Blanchett says. “Before, advisers would always recommend a rollover. This should leave more money in plans.”

“The first question sponsors are asking themselves in response to the fiduciary rule is how it impacts their relationship with their recordkeeper,” Donoghue says. “Many are asking themselves if there is a conflict of interest if the recordkeeper is also managing the assets.”

Cook sees it somewhat differently. “The fiduciary rule presents an opportunity for DCIO asset managers to help retirement plan advisers: by providing them with products and services to fulfill their fiduciary responsibility, by educating them on trends and by providing thought leadership pieces. One example is the importance of costs. A DCIO provider can proactively tell an adviser when a plan may qualify for a lower-cost share class.”

All told, advisers look to their DCIO providers for a host of services, indicating that these providers need to step up to the plate.