DC Plans Ended 2013 Strong

Defined contribution (DC) plans outperformed defined benefit plans significantly during the fourth quarter of 2013 and during the whole year, according to a recent analysis.

The Callan DC Index, which tracks the cash flows and performance of over 80 DC plans, indicates that DC plans ended 2013 strongly, advancing 6.23% in the fourth quarter. This contributed to a very impressive calendar year return for the index of 20.15%, making 2013 the index’s best year since the 2009 rebound, when it was up 22.22%.

DC plans tend to have much less exposure to longer-term fixed income than defined benefit (DB) plans, say the authors of the index, which accounts for much of the difference in performance. However, DB plans’ greater diversification also tended to work against them in 2013.

While the typical corporate DB plan has nearly 2.5% in hedge funds and another 4% in other alternatives, the index shows that the typical DC plan has just a tiny fraction of a percent of such exposure. With domestic equities bringing in such blockbuster performance in 2013, the index indicates that it was difficult for alternatives to compete.

By the end of 2013, DC plans outperformed DB plans by an average of 7.59%, according to the index. This, in turn, significantly narrowed the performance advantage that corporate DB plans have demonstrated since the index’s 2006 inception. Between 2006 and 2012, corporate DB plans outperformed DC plans by 1.8% (average, annualized). Through year-end 2013, DB plans’ performance advantage had been squeezed by recent DC strength to less than half a percentage point annually.

The index also finds that the trend in target-date funds (TDFs) also experienced a bit of a reversal during the year. Normally, TDFs have tended to outperform DC plans in rising markets, say the authors of the index. But in 2013, TDFs lagged slightly with the average 2035 target date fund advancing just under 20% for the year.

For the year ending December 31, 2013, the index shows that DC plan balances soared 22%, driven almost exclusively by market returns. Plan sponsor and participant contributions (net flows) added 1.85% to growth during the year, or less than 10% of the total growth in balances. The index shows that over time, plan sponsor and participant contributions have tended to do more of the heavy lifting; accounting for one-third of the total growth in balances (2.84% annualized) since the index’s 2006 inception.

The index shows that target-date funds remained the recipient of much of the money that flowed in DC plans during the quarter and the year. Nearly 80 cents of every dollar that moved within DC plans headed for TDFs in fourth quarter 2013, and more than 70 cents of every dollar did so during the year. In contrast, more than half of the asset classes tracked in the index experienced net outflows during the quarter. This includes two of its best recent performers, company stock and domestic large cap equity. Domestic fixed income and stable value both suffered significant outflows. Overall turnover (also known as net transfer activity levels within DC plans), was below average for the quarter and for the year at 0.64% and 2.09%, respectively.

Target-date funds took another step forward during fourth quarter 2013 to becoming the single-largest holding in the typical DC plan, accounting for more than one-fifth of total assets (21.1%) within the index. Only domestic large cap equity allocations are higher, at 23.7%, followed by domestic small/mid cap equities at 11.9%. While TDFs have never experienced a quarter of net outflows since the index’s 2006 inception, domestic large cap equity has seen outflows more than two-thirds of the time, including the fourth quarter.

Overall, the index’s total equity allocation has increased to over two-thirds (66.8%) of DC plans’ assets. This allocation has been trending slightly upward since the end of 2012. However, it is below the index’s historic high of more than 70%, reached prior to March 2008.

The Callan DC Index, which is produced by the San Francisco-based Callan Associates Inc., is an equally weighted index, representing more than 800,000 defined contribution participants and over $100 billion in assets. The index is updated eight to 10 weeks after the end of the quarter and reflects 401(k) plans, as well as other types of DC plans.