The Markets June 3, 2007

Investment Only to Grow in the Future

Market dynamics bear promise for investment-only firms in the defined contribution space.
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However, in order to succeed in the marketplace, each firm will have to firmly evaluate the opportunities available to them.

Firms in the retirement plan space are looking to grow their defined contribution assets, as a result of the reduced opportunity in the defined benefit arena, a recent Cerulli survey showed.

Nomenclature

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What exactly is investment-only? According to Cerulli, precisely defining industry monikers, such as investment-only, is critical to helping firms accurately identify specific opportunities and define strategies moving forward.

The term investment-only originated as a way to differentiate between DC business in which the asset manager also served as the recordkeeper and those cases in which the manager only acted in an investment capacity. However, Cerulli asserts, the term is a misnomer because such firms that operate in the defined contribution market often do much more than just manage the investment piece.

According to Cerulli’s research, financial services firms are split between those who are opposed to the use of the term “investment-only” as the umbrella term to describe retail assets that flow through some sort of gatekeeper, as there are firms that support the adoption of IO as the overarching moniker to describe professional buyer-intermediated retail assets.

Opportunities

Investment-only opportunities in the defined contribution marketplace represents a meaningful opportunity, the Cerulli report says; although there will be a difference between managers who already manage a significant amount of DC IO assets and are looking to foster continued growth, and those managers just beginning to gather DC IO assets. According to Cerulli, all managers will have to determine whether they are interested in managing simply the investment components of participant products, or if they want to manage the end product as well.

Further, there are two approaches to DC IO opportunities, Cerulli says; pure-play firms that offer only investment solutions, and hybrid firms that offer full-service bundled DC programs, as well as unbundled investment offerings that are available on a stand-alone basis on other investment platforms.

The total investment-only market in 2005 was $2.87 trillion dollars, most of which ($1.1 trillion) was in the defined contribution investment only market. In addition to expected growth in the defined contribution marketplace, IO opportunities will also be driven by what Cerulli describes as “the slow by steady decline of proprietary fund use and the demand for open architecture’ in the defined contribution marketplace.

In order to best capture these opportunities moving forward, firms must “tailor their marketing techniques to ensure that they are providing the right type and amount of information to a broad range of gatekeepers.’ Further, Cerulli said, asset managers should evaluate the investment-only prospects in the defined contribution marketplace as part of their firm’s overall professional buyer-intermediated relationships and the marketplace opportunity for their firm.

In fact, almost 67% of firms are turning their focus to increasing clients through defined contribution programs, and Cerulli says that investment-only (IO) opportunities will make up a significant percentage of opportunities available to these firms. Fifty-six percent of firms plan to increase their work with investment consultants, 50% say they are looking at other institutional segments and one-third are looking at retail segments.
IMHO June 3, 2007

IMHO: Life Lines

A couple of weeks ago, I stumbled across a paper published by the National Bureau of Economic Research titled “New Estimates of the Future Path of 401(K) Assets.″
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In this particular case, “new’ appeared to relate to the paper, not the future path of 401(k) assets. Bottom line: 401(k) assets are going to keep growing, and at a better rate over the next couple of decades than they have the past 20 years (there was also a brief article on this paper in the New York Times last week, which you also may have seen syndicated locally). In fact, the paper notes enthusiastically, “We conclude that the increase in the pension assets of future retirees will be much greater than the assets of current retirees.’
This is good news, of course, since such programs seem destined to represent the primary retirement savings in the decades to come. We need them to grow, and we need them to grow faster than they have heretofore, certainly based on the average and, more significantly, median account balances reported from various sources.
Past Comparisons
Projections of the future are, inevitably, based on understandings and extrapolations of the past, and this paper is no exception. The paper’s authors remind us that 401(k)s are a relatively recent “invention,’ with contributions to them beginning only in 1982. Thus, the argument goes, the balances in today’s retiree accounts have not had as long to accumulate as will those who retire 40 years hence. Moreover, they compare data from 1984 with that in 2003 that illustrates a large increase both in the number of workers eligible for a 401(k), and in those actually choosing to participate. In essence, today’s retiree balances have suffered from both a late, and a slow, start relative to the retirees of the future. And, since the retirees of 40 years hence will have had “full’ access to the benefits of saving (and investing) via a 401(k) for their entire working lives, they will wind up with more—significantly more—In the way of savings accumulations than their parents.
None of this is particularly controversial logic, though it seems to me that it ignores another reality—that defined contribution savings programs existed well before the advent of 401(k)s. As a mid-range Boomer, I was saving in my employer’s “thrift incentive plan’ for the “free money’ from a match just as soon as they would let me (waiting a year to be eligible was normal in those days). My savings weren’t pre-tax then, of course (1979)—but the earnings and company match were.
Different Now?
Now, it is entirely possible that the advantages of pre-tax savings drew the attention of workers in the 1980s who had not previously taken advantage of various “thrift’ plan alternatives—programs that were (including stock bonus and profit-sharing), in large part, subsumed (in name, anyway) into the newer 401(k). It is equally possible that the nation’s economic resurgence in the 1980s led employers to offer 401(k)s that had not previously offered a defined contribution plan, or that the tightening labor market of the 1990s compelled employers to offer new programs as a competitive advantage. Furthermore, there seems little doubt that the decline in coverage and availability of traditional pensions, and the widespread media coverage of same, has more recently led some to contribute to their own retirement security in amounts they might not otherwise.
Still, while we certainly have more ways to save today, ways that are generally “better’ and more “convenient’ (don’t even have to fill out an enrollment form these days) than they were 20 years ago, the savings rates I hear reported for younger workers today strike me as remarkably consistent with those of the past. IMHO, choosing to save for retirement, or for any purpose, is—and always has been—about balancing current economic realities with long-term goals. Generally speaking, the former looms larger the younger—and poorer—you are.
There’s little question that the 401(k) has attained a certain ubiquity (though it’s worth remembering that most American workers aren’t covered by a workplace retirement plan). But we shouldn’t assume that just because more workers have an earlier ability to participate in a 401(k) plan—and for their entire working lives—that they will do so. We—and they—can’t afford to.
The research paper is online at http://papers.nber.org/papers/w13083.pdf

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