Fri, 02/08/2019 - 11:59
At nearly USD8 trillion, the US defined contribution (DC) retirement market remains one of the largest – and growing – opportunities for asset managers. From 2007 to 2017, net assets grew by 67 per cent, increasing by USD3.1 trillion.
Based on Strategic Insight’s most recent projections, the DC market is expected to reach approximately USD10 trillion by 2022, which represents a further increase of USD2.3 trillion in net assets over the next five years. Find out how industry peers are taking advantage of this opportunity.
US defined contribution retirement
A growing market that’s growing more complicated
To take advantage of this growing market, defined contribution investment only (DCIO) firms – which are asset managers that provide investment products through the platforms of nonaffiliated recordkeepers – have created or bolstered dedicated DCIO teams. These teams ensure that they have adequate investment products, sales and support staff, as well as value-added tools and resources for their distribution partners, recordkeepers and advisers.
As recently as a decade ago, assets managed in the DC market were equally divided between proprietary and externally managed DCIO assets. However, as the retirement market has matured and changed over the past few years, the share of DCIO assets has risen to 60 per cent of total DC assets.
As DC plans have become the sole retirement vehicle for many individuals, we expect that this market will continue to be a substantial area of asset and revenue growth for asset managers; however, growth will be achieved only by overcoming a number of challenges. These challenges include the effect of the introduction of the Department of Labor (DOL) fiduciary rule in 2016.1 Even though the rule was shelved in early 2018, its introduction resulted in the industry being faced with issues of heightened fiduciary obligations, as well as greater fee disclosure and transparency requirements. Other factors that have come into play over the last few years include an increased usage of target date and passive products, a more intensely competitive environment, and the need for managers to allocate additional resources to manage and maintain key relationships.
A new DCIO environment
These and other challenges that affect the retirement market have made it more difficult for DCIO firms to garner additional market share and maintain their influence over existing relationships. Nevertheless, there are ways for DCIO firms to expand their level of engagement with key clients, advance their relationships with distribution partners and, as a result, secure additional assets.
Three major developments have changed the way DCIO firms evaluate their opportunities and approach the DCIO market:
1. The wide acceptance of target date funds (TDFs) and passive products, as well as the reduction in shelf space
2. Concerns about potential conflicts of interest when working with distribution partners
3. The continued high concentration of assets amongst the top recordkeepers
Crowding out by target date funds, passive product and reduction in shelf sizes
Historically, the success of DCIO firms came through single-strategy, active mutual funds, a sector that was estimated to have reached USD2.6 trillion by the end of 2017. However, following the introduction of the Pension Protection Act (PPA) in 2006, there has been a material shift towards target date funds reflecting their status as an approved qualified default investment alternative (QDIA). The use of TDFs has become widespread, reaching approximately USD700 billion in assets in DC plans by the end of 2017.
While TDF products have been dominated historically by a handful of asset managers, typically those with their own recordkeeping units and closed- architecture structures using only proprietary funds, the last several years have seen an increased use of nonproprietary managers within TDFs.
As many TDF providers have included high allocations to equities within their proprietary funds, managing sources of risks, such as manager and asset class diversification, have become increasingly important to maintaining best interests for participants. As such, one of the differentiating factors some TDF providers use has been the inclusion of alternative asset classes or solutions, such as hedge funds, commodities, real estate and high-yield bonds. The inclusion of asset managers with expertise in these niche categories within TDFs has had a material impact on reducing overall risk and providing broader and more diversified allocations than recordkeepers have been able to offer from their own funds or managers.
At the same time, passive products have experienced a surge in demand as a direct result of a greater scrutiny on the level of plan fees and growing concerns surrounding the value represented by active investment management strategies and the fees charged. While DCIO firms with a bias towards passive strategies have benefited from this shift, overall margins on investment products have started to deteriorate as assets shift from active solutions to passive.
Consistent with the ongoing trend of product rationalisation, other immediate concerns for DCIO firms include further recordkeeper shelf consolidation and restricted access to plan shelves. However, DCIO firms that have a solid record of good performance and are willing to negotiate on fees are often able to maintain relationships and win new mandates, despite thinning shelf space.
Concerns about conflicts of interest when working with distribution partners
As a centre of influence in the retirement market, recordkeepers act as investment product gatekeepers able to influence the nature of investments offered on their platforms. In addition to controlling investment offerings, recordkeepers have access to detailed knowledge about plan sponsors, the underlying participants and the advisers attached to the plans.
Before the introduction of the (subsequently vacated) DOL fiduciary rule, recordkeepers and DCIO firms worked in concert, with DCIO firms providing support and services in exchange for distribution support, whether in the form of product approval or intelligence on advisers selling their funds. However, as a result of the DOL’s proposed rule, the relationship between asset managers and recordkeepers changed significantly. To avoid running afoul of the new proposed regulations, recordkeepers evaluated their business practices to eliminate perceived conflicts of interest, such as those arising from partnerships seen to be giving advantages to various firms through being placed on preferred lists. In response to the DOL rule, DCIO firms, recordkeepers, advisers and other service providers relaunched products, revised disclosures, and adjusted pricing models with an eye towards greater transparency and accountability.
However, after nearly a decade in the making, amid significant industry objections, the DOL’s fiduciary rule was officially vacated in early 2018. Despite the failure of the fiduciary rule to be enacted, it’s nevertheless likely that its core drivers of investor protection and best interests will persist for some time. Indeed, in April 2018, the Securities and Exchange Commission (SEC) issued a proposed set of new rules that share many similarities with the abandoned DOL’s fiduciary rule.2 However, the SEC is also taking comments from the industry, and as such, the initial proposal may change significantly before it’s finalised.
The concentration of assets remains high amongst top recordkeepers
The top 10 recordkeepers by assets hold a disproportionate, and still growing, share of the market. Over the past three years, the share held by the 10 largest recordkeepers increased by four percentage points, from 68 per cent in 2014 to 72 per cent in 2017. Over the same period, the 10 largest recordkeepers also increased their share of plan participants from 58 per cent to 63 per cent, despite a declining share in the number of plans, from 27 per cent to 22 per cent, reflecting the effect of corporate and plan mergers.
Normally, concentration of assets is seen as a positive development for DCIO firms, as it will allow them to focus their efforts on fewer recordkeepers and plan sponsors. However, with so many DCIO firms vying for a share of the market, it has become increasingly difficult to attract the attention of the recordkeepers and to negotiate the placement of products onto their shelves. Prioritising efforts on product development and investment performance, as well as increasing support for sales teams through unique tools and thought leadership activities, large DCIO firms, such as BlackRock, Vanguard, Nuveen, State Street Global Advisors and T. Rowe Price, have experienced double-digit positive growth.
As demand has shifted towards professionally managed investments and lower cost funds, DCIO firms that have TDFs or significant passive strategies have done well. Although large TDF providers, such as Vanguard, Fidelity and T Rowe Price, have dominated the market in terms of gathering assets, many DCIO firms below the top 10 also experienced double-digit growth from 2016 to 2017. This group included firms such as Fidelity, MFS Investment Management, AllianceBernstein, and Dimensional Fund Advisors, as well as Janus Henderson and MassMutual below the Top 25. All of these firms succeeded due to their ability to fill a style/strategy gap, produce good fund performance, maintain investment team stability, and provide style consistency and quality of service.
Ways for DCIO firms to maintain their influence
As key business strategies for recordkeepers remain focused on ensuring that their platforms offer the most appropriate investment options across a universe of best-in-class managers, DCIO firms have found themselves partnering with recordkeepers and advisers in a broader capacity than in the past.
Earning influence through product range
As DCIO firms are engaged with their clients primarily through the provision of investment products, the way to best strengthen a relationship is through offering a competitive range of products. Key success factors include providing products at a low cost whilst maintaining transparent cost structures, and delivering differentiated products that clearly add value to the portfolio and help meet plan participant objectives.
Within mutual fund share classes, R6 or zero/zero, classes meet both these criteria given that the design of the class eliminates any revenue-sharing concerns and represents the lowest cost mutual fund share class available in retirement accounts. R6 shares accounted for the lion’s share of mutual funds sold into retirement plans in 2017.3
Collective investment trusts (CITs), historically sold to only institutional-sized plans, are an alternative to mutual funds and align with the low-cost criteria. On average, CITs can cost between 10 to 30 basis points less than mutual funds with similar features, as the product benefits from being exempt from registration and filing requirements with the SEC.4 The exemption from SEC oversight further provides CITs with the ability to provide flexible pricing and more leeway to invest in illiquid alternatives. In the large plan sector (USD1 billion plus), the share of CIT assets increased from 37 per cent in 2014 to 40 per cent in 2015.5 This shift in demand in large plans may be a precursor to greater adoption in the smaller plan market.
CITs provide a very accessible option for DCIO firms to provide custom offerings that may best meet the needs of the end client. Plan sponsors may request a manager to customise a fund to a specific need through, for example, the exclusion of certain securities, renaming a fund to simplify investor communication, or by creating branding specific to the plan. Many of the largest plan sponsors, such as Delta Airlines, General Motors, Kaiser Permanente, Lincoln National, and United Technologies use CITs for these reasons. Given the success of R6s and CITs over the past few years, firms that can offer their products through multiple product types will have a greater opportunity to strengthen existing relationships.
Earning influence through services
A critical partner for DCIO firms, aside from the recordkeeper, is the plan adviser. Long seen as a group representing “sticky assets” with unique needs and a longer sales cycle, plan advisers are specialised in retirement services. Increasingly, DCIO firms have sought to appeal to advisers less through investment dialogue and more through support programmes, specialised tools and dedicated resources.
According to a survey of DCIO firms conducted by PLANADVISER, a number of service offerings, such as due diligence meetings, access to investment committee meetings and research (such as white papers/commentary on overall trends or specific insight/tools into funds, stocks or asset classes), have become critical to remain competitive. Other DCIO value-added services that have increased over the last year include conferences for advisers and TDF evaluation tools. Some DCIO firms, such as State Street Global Advisors, seek to be a key resource to plan sponsors by providing tools and research in participant communication, record keeping practices, public policy and plan design.
In addition to providing expert staff to support these value-added services, as advisers become more reliant on firm websites and other easy-to-access support tools, there will be a continued need for ongoing sales and marketing support due to the intricacies involved in the DC plan sales process.
A way forward
As the US retirement market matures, the DC market is forecast to grow at an average annual rate of 5 per cent from 2018 to 2022.6 At nearly USD8 trillion, it represents a large and growing opportunity for DCIO firms, particularly as recordkeepers increasingly open up their solutions to nonproprietary investments.
Despite some of the challenges facing DCIO firms today – such as the proliferation of TDFs and passive strategies and the focus on low-cost structures – asset managers can maintain or even increase their presence by adapting products, offering multiple product types and providing value-added services in the form of retirement research articles, financial calculators and specialised tools.
Prioritising sales and support staff and expanding marketing resources has proven successful for DCIO firms, but this tactic may prove more successful to larger asset managers who are in a better position to (re-)allocate resources. However, despite the fact that the largest DCIO firms gathered the majority of assets, many DCIO firms with assets below USD100 billion have experienced double-digit growth year over year.7 While the further streamlining of investment menus may pose a limiting factor to DCIO firms, it also represents an opportunity for those whose investments are in niche asset classes and whose offerings are clearly differentiated compared to established competitors.
Greater attention on participant outcomes and managing key risks will further shift the industry to take an institutional investment approach through broad asset class and manager diversification, use of best-in-breed investment management, and inclusion of alternative asset classes. This shift will make it more difficult for recordkeepers to justify their using their own proprietary products to attract and retain clients. We expect that this will lead to an even greater demand for open- architecture structures and inclusion of nonproprietary managers that deliver solutions that more closely add value to, and benefit, plan participants. DCIO firms that can meet existing demands with low-cost products that diversify risk or fill a style/strategy gap in broadly marketed or custom fund lineups have a stronger chance of success in gathering DCIO assets in today’s competitive environment. Additionally, DCIO firms that provide multiple value-added services to distribution partners will be well-positioned to maintain their influence in the competitive DCIO market and secure additional assets.
1 Congressional Research Service, “Department of Labor’s 2016 Fiduciary Rule: Background and Issues,” Congressional report, 3 July 2017.
2 US Securities and Exchange Commission, “SEC Proposes to Enhance Protections and Preserve Choice for Retail Investors in Their Relationships With Investment Professionals,” 18 April 2018.
3 Strategic Insight, 2017 DC Asset Manager Product Survey.
4 PLANSPONSOR, “CITs seen as an advantage over mutual funds,” 8 February 2017. 5 BrightScope, Defined Contribution Plan database, 2018.
6 Investment Company Institute; Strategic Insight.
7 Strategic Insight data and analysis, June 2018.