DCIO Update: Evolutions in Investing

Market volatility and an aging population will pressure the DCIO market in coming years. But the industry continues the push for improvements, such as more personalization for savers.

In a video called “Bob’s First Day” by Morningstar, a new employee asks his benefits contact for advice about the company’s 401(k). What transpires is a conversation in which the representative goes over several “personalized” options for Bob that don’t match his true income or financial situation. The episode is designed, in short, to show the experience of being put into a basic target-date fund.

“It’s hilarious,” says Sean Bjork, president of Bjork Asset Management.

Bjork is not against TDFs in retirement income plans. He, like most advisers, sees them as a key vehicle in retirement saving to accumulate wealth at the appropriate risk level for a participant’s age. But the video, as he sees it, reveals the need for continued innovation and customization in defined contribution investment only.

“I think there is a huge benefit to the participant in personalization,” Bjork says. “TDFs are miles better than most of us would do on our own. The interesting question is around what more we can do with personalization.”

The DCIO space has, of course, evolved over the years to improve the saving options and outcomes for millions of retirement plan savers. At the end of 2021, the DC market held $8.5 trillion in savings, according to the latest data from ISS Market Intelligence, which, like PLANADVISER, is owned by Institutional Shareholder Services Inc. DCIO has also evolved along with the U.S. economy, ISS MI notes, with job categories such as finance, technology and health care driving the DC market, though manufacturing, an old stalwart, continues to represent a large portion of assets.

Bjork has seen, over the years, advancements such as the use of lower-fee collective investment trusts for midsize to small plans, as well as a more refined pool of both passive and actively managed fund options. While DCIO has room for growth, he even sees hope for “Bob” as the industry tests the early stages of more personalized TDFs that can take into account a participant’s individual situation.

Our annual PLANADVISER DCIO survey is an industry resource for just how far, and how fast, the market is evolving. Below are a few of the areas to watch.

CITs: Pros and Cons

According to defined contribution tracker Chris Brown at Sway Research, CITs are projected to top mutual funds as the primary target-date vehicles this year. Sway Research reported in February that, over the last five years, assets in CIT-based solutions grew an average of 15% annually, compared with 6% for those based in mutual funds. For each new mutual fund series, there were seven new CIT target-date series launched in 2022. 

CIT providers such as Great Gray Trust Co. (formerly Wilmington Trust’s CIT division), have been pushing innovation in the space to make what can be a cumbersome process for plan sponsors to bring on CITs smoother and more transparent, in turn expanding the market for these DC-only investment vehicles.

“We are starting to see more plans in the small and midsize market take advantage of CITs,” Julie Wimer, director of client service and product at Great Gray Trust, told PLANADVISER in May.

From adviser Bjork’s side of the aisle, the push by providers has been working; in recent years, he has been including CITs in the plan menus of more midsize and small firms. That’s in part, he says, because minimum thresholds for plan sponsor DC assets to be able to offer a CIT have gone down, and interest from plan sponsors has gone up when they see the potentially lower fees.

“We’re seeing a lot more value-add through use of scale in some of the CIT offerings,” Bjork says. “It’s a slow process in terms of educating the [retirement plan] committee in terms of here’s what this is, and here’s what the differences are from a mutual fund. … But that comfort level is there now, and I think it’s a much easier discussion.”

Not everyone has had the same experience. Patrick J. Morrell, an investment analyst with Renaissance Benefit Advisors Group LLC who works with retirement plan advisers, says there is still a lack of availability of CITs for small and midsize plans.

“When we recommend investments for a plan, we follow a prudent search and selection process that begins with the Morningstar universe of investments by category and ends with a short list of options that we feel confident recommending to a client or committee,” he says. “In many cases, the investment strategies that we recommend to clients are either (1) not offered in a CIT or (2) the mutual fund, along with a revenue-sharing credit, comes at a near or lower cost than the CIT.”

Morrell says when a CIT is introduced to the market based on his team’s strategies, it will consider recommending the CIT if the fees are attractive and the CIT assets are “considerable and rising.”

Mutual Funds Chill Out

Despite the growth of CITs in the DCIO market, mutual funds are still, at the moment, the dominant investment vehicle. The funds managed 62 percent of all assets in 401(k) plans at the end of 2022, according to the latest date from the Investment Company Institute. There has, however, been continued use of either passive or hybrid passive/active funds within plans, with researcher Sway again noting that passive fund inflows have been outpacing active—though that can be done both through mutual funds and CITs.

Investment analyst Morrell says his team often offers five passive strategies across U.S. and non-U.S. equity and one intermediate-term bond index fund.

“Paired with active strategies in growth, value, emerging markets and differing bond sectors, it grants participants the opportunity to build a low-cost, passive portfolio or commingle index funds with active strategies as they deem appropriate,” he says.

When analyzing investments, his firm has “not observed a lot of consistent success among active managers in outperforming a market index, or by reducing risk,” Morrell says. “We have found ,that many times, an index fund has consistently provided better relative returns and risk than the average peer portfolio in the Morningstar universe.” 

Retirement plan adviser Bjork shifts the conversation of passive versus active back to the needs of the plan and its participants.

“You can use passive where it makes sense, and you can use active where it makes sense, and you don’t have to drink the Kool-Aid on either side of the spectrum,” Bjork says. “If [an investor] just wants the beta and exposure and they want it really cheap, that is a reasonable stance. But for fixed income or emerging markets, or things where there is more friction, indexing may not make the most sense, so you can go with a good, healthy mix of both.”

TDFs Evolve

The title of a recent blog by asset manager PIMCO may say it best when it comes to the next frontier of TDFs: “Coming Next to DC Plans: Personalized Target-Date Funds.” The fixed-income manager’s post brings us back to Morningstar’s new employee Bob, promising him that the next generation of TDFs that will take into account “attributes of each participant—not only age but also their balance, salary, and the percentage of compensation they and their employers contribute to the plan. The goal: an asset allocation better calibrated to the risk and return needs of individual participants.”

Adviser Bjork is starting to see this evolution of TDFs emerge in conversations about DCIO options, but he sees a lot of work to do before personalized TDFs are ready for use.

“They might not be in the early innings yet,” he says. “It might be better to say they are in batting practice.”

What such a DCIO vehicle would mean, in practice, is an evolution in technology that gathers information from a participant and then pipes it to a target-date provider to create their investment. “Being able to do that in a way that creates value and hopefully doesn’t cost anything extra is going to be interesting,” Bjork says.

In addition to large players like PIMCO, there are digitally-driven retirement advisers such as GuidedChoice, based in Reno, Nevada, that are touting personalized TDF options as the wave of the future.

Morrell notes other types of innovations his team is exploring in the TDF space. Recently, it has been looking at a TDF strategy from State Street Global Advisors that offers a “more diverse mix of passive index funds than Vanguard or Fidelity are currently offering,” he says. His team is also interested in a PIMCO TDF that uses low-cost Vanguard equity index funds paired with actively managed PIMCO fixed-income funds.

For now, however, the quest for low fees, steady returns and the right risk balance will likely continue to dominate the DCIO marketplace.

“There has been ongoing evolution of target-date fund strategies since their inception more than two decades ago, and yet some of the best target-date strategies from a risk/return standpoint have tended to remain the same throughout time,” Morrell says. “No gimmicks or tricks … a prudent asset allocation, reasonable fees and consistency along the glidepath has remained the most competitive in our view.”

Morrell also points to a trend of less, not more, in DC investment plans.

“We have continued to see the number of available investment options slowly decline with time,” he says. “With the addition of a target-date fund family, we’re seeing much less usage across more esoteric asset classes and at times have recommended eliminating unused funds or those in volatile, opaque asset classes.”

That may be the real challenge for the DCIO industry: provide fewer, but better options.

—Alex Ortolani