2022
PLANADVISER DCIO Survey

DCIO Momentum

How the market is continuing to grow and evolve

Recent market volatility notwithstanding, defined contribution investment only funds continue to dominate within the defined contribution space. Sway Research projected, last October, that the market would reach nearly $8 trillion by the end of 2025 and comprise 60% of the total DC market, up from 57% in 2021. As it has grown, the DCIO landscape has been evolving, and broader industry trends such as mergers and acquisitions and fee compression have been playing out among both DCIO-only providers and recordkeepers.

Because qualified default investment alternatives remain the primary recipients of participant earnings deferrals—87% of plans in 2021 had a QDIA, according to Vanguard—they remain the focus of the DCIO industry. “DCIOs really want and need to be a part of the QDIA discussion, whether it’s managing a portion of a managed account, or some kind of multi-manager target-date fund solution, or a target-date fund suite,” says Jim Keenehan, a senior consultant, retirement plans, with AFS 401(k) Retirement Services in Bethesda, Maryland.

What follows is a look at several key trends in DCIO right now.

Home Offices Lead

The ongoing wave of consolidation has fundamentally altered the industry landscape. “The industry used to be all three-person teams, maybe 10 people in an office,” says Michael Esselman, vice president of investments with OneDigital Retirement + Wealth in Atlanta. “While we were all under the same RIA [registered investment adviser], there was no mandate or recommendation to use specific funds. Then the acquirers came along, and we became employees rather than affiliates. You gain a lot, but you also give up some things, such as fund selection.”

While the requirements for appearing in a “model group” or on a “preferred list” vary by firm, home offices, in general, are taking the lead on investment decisions, and the end result is that it has become far more important for the DCIO providers to work to get onto those lists.

“The industry is looking for very thoughtful relationships where like-minded advisers and wholesalers understand their plans and their value add,” says Tim Kohn, head of the retirement distribution group at Dimensional Fund Advisors in Austin, Texas. “The industry is going through this dance right now to figure out who are the best half-dozen organizations to work with. I don’t see DCIO shops working with everyone at the same level.”

The Shift to CITs

Another result of continued industry consolidation is the rise of collective investment trusts, as DCIO providers look to offer relationship pricing—i.e., more favorable pricing, including the ability to purchase funds at scale—to larger adviser firms. “Our view is that we’re not asking for better prices than is anyone else, but we also don’t want to be undercut by a competitor that can come in and get the fund for cheaper,” Esselman says. “The relationship-pricing conversations all have a different flavor, which is interesting to see, but these are clearly important, and [DCIO providers] are approaching us more often than we’re approaching them.”

While mutual funds still comprise the bulk of DCIO assets, CITs have been steadily gaining market share. As of last October, CITs had 34% of DCIO market share, up from 28% in 2018, Sway research found. With more than $2 trillion in assets under management last year, CIT products could overtake mutual funds in DCIO asset share by the end of 2025, Sway projected.

That trend does not surprise Keenehan, who says for years his clients have been focused on making sure their advisers are aware of the lowest-cost versions of funds and are benchmarking the fees and performance of recordkeepers’ services. “So now that means shifting them out of mutual funds and into collective investment trusts,” he says.

Ken Barnes, an investment consultant with SageView Advisors in Glen Allen, Virginia, says his firm has moved more small and midsize plans into CITs over the past year, whereas previously only the largest plans made that transition. “We’ve put a lot of time and effort into working on relationship pricing and how to leverage our scale with different investment managers to negotiate lower investments costs for our clients. And a lot more of our clients have become receptive to CITs,” Barnes says.

Marrying Income and TDFs

Although target-date funds remain the default option for the vast majority of 401(k) plans—e.g., among plans with a QDIA, 97% of the alternatives chosen were target-date funds, Vanguard found—some plan advisers are talking to plan sponsors about potential changes to how the target-date fund is structured, such as the introduction of income solutions, Barnes says. And, while there is a growing awareness that plan sponsors and participants are looking for ways to allow for lifetime income, there is no consensus yet on the best approach, he says.

“I don’t think the perfect solution is out there yet,” Keenehan says. “Everyone wants to be ahead of the curve and come up with one of the most successful solutions, but there are still a number of challenges, including pricing, portability and simplification of these strategies.”

The shift toward income products will get an additional boost in some plans when a provision from 2019’s Setting Every Community Up for Retirement Enhancement Act goes into effect in September. This requires that a disclosure appear on participants’ statements, at least once in any 12-month period, that translates their balance into potential income, Kohn says. He sees that requirement as a “green light” for product development that focuses on providing income. The result should be a transition from first-generation target-date funds to next-generation target-date funds, or target-date-income funds, he says.

While target-date funds in their current iteration do a good job of helping participants save for retirement, they are not designed to help with spending down those assets once the person’s golden years begin, Kohn says.

Matt Brancato, principal and head of client success at Vanguard in Devon, Pennsylvania, observes that, as the industry embraces income solutions, this presents an opportunity for a wider range of them. “We have shifted from questions about whether annuities belong in a plan to more sophisticated conversations about how to combine investment products with the guidance investors might need to navigate a complex decumulation situation,” he says.

Advice and Managed Accounts

Another area within QDIAs where Kohn expects evolution this year is managed accounts. “There are so many great providers out there that are allowing advisers to customize managed account solutions, which were very high-touch fiduciary concerns even a few years ago,” he says.

Barnes says his firm has seen more interest from plan sponsors, which are starting to consider managed account solutions. “They’re looking at them as an opt-in solution or even considering them as part of a dynamic QDIA, where you’re defaulted into a managed account after age 55 or 60 from a target-date fund,” he says.

Even for plan sponsors not ready to make the switch to managed accounts, arranging for advice remains important, and it is a vital value-add for providers. “Advice is paramount, and the use of a financial professional at some point in someone’s financial life is very important,” Kohn says. “We are seeing fintech help automate that. We’re going to see that become more and more prevalent as new entrants create mass customization for advice.”

Barnes has seen a similar trend and interest among his clients. “I can’t think of a client we have won in the past few years where we didn’t include advice and education,” he says. “We offer a CFP [certified financial planner] line where participants can call in and get point-in-time fiduciary advice. In markets such as this, we’re seeing a real appetite for that service.”

According to Brancato, many plan sponsors want their providers to offer advice to participants, as they are unable to do it themselves. The ability of DCIO providers to offer advice within managed accounts remains a differentiator, and Brancato projects that advice will become an even more important component of retirement plans over the next decade, with an evolution in the type of advice offered, including third-party advice options.

As plan participants get older, and their financial lives get more complicated, that advice component becomes even more important, Brancato says. “Individuals with complex circumstances have more complex decumulation needs,” he adds. “It might make sense for them to start in the target-date fund and then, over time, migrate to a low-cost advice product that meets those more complex needs.”

An Eye on ESG

Despite the industry conversations about introducing environmental, social and governance options into 401(k) plans in recent years, there has been little movement to do so, according to Swift.

“It may be something that plan participants are asking about, but I don’t know if I’d say the same about plan sponsors,” Keenehan says. “They’re not proactively reaching out and asking about ESG, but they’re [intrigued] when we bring it up. It piques their interest.”

Even so, plan sponsors that have introduced ESG options into their plan menu have not seen significant uptake, Keenehan says, but he concedes that that is likely because such funds are not in the QDIA, meaning that simple inertia may be keeping some participants from opting into such investments.

Still, as more younger people enter the workforce and begin contributing to a 401(k), Keenehan says, he expects that interest to grow. “ESG is more of a long play that will happen over time,” he says.

Barnes has a similar outlook regarding ESG and notes that while the Department of Labor has issued proposed rules that support ESG funds within 401(k) plans, many plan sponsors are waiting for that guidance to be finalized. “I have found that demand from my clients is much lower than the appetite seems to be in the investment industry,” he says. “That might change when we get the final rules. For now, we see it as something that’s worth talking about with our DCIO partners, but it’s not something I’ve seen strong adoption of with plan sponsor clients.”

From Brancato’s perspective, ESG continues to be an area of both innovation and debate. “The big thing we’re hearing from plan sponsors is they need clarity from a regulatory perspective, before we’re going to see any mass adoption of ESG,” he says. “What we’re hearing is that there’s more interest. So, like with any other trend, we are doing a lot of research on how we can help investors drive toward those outcomes and incorporate the ESG preferences they’re looking for.” —Beth Braverman

Art by Lars Leetaru