TDFs, Passive Funds and Income Products Shape the DCIO Landscape

Sources say plan sponsors are beginning to realize the value of differentiating services—from retirement income solutions to securities lending capabilities—now that costs have come down across the board.

Art by Tim Peacock

The most important development in the defined contribution investment only (DCIO) marketplace to consider is the fact that the lion’s share of assets are being attracted into the target-date funds (TDFs) offered by Vanguard, American Funds and State Street Global Advisors, says Chris Brown, principal and founder of Sway Research.

In fact, Sway’s third quarter 2019 report on DCIO sales shows that year-to-date through that quarter, DCIO assets were up an average of 14%—but Tier 1B firm’s assets were up 21.9%. Furthermore, year-to-date gross sales for the average Tier 1A firm were five times that of Tier 1B firms, 12 times the average of Tier 2 firms and 25 times the average for Tier 3. For context, Sway’s research breaks the DCIO market down into three tiers based on firms’ relative market share.

While plan sponsors have been seeking the lowest cost offerings from their DCIO providers, James Martielli, head of defined contribution (DC) advisory services at The Vanguard Group, says that sponsors are beginning to realize the value of “differentiating services,” now that costs have come down across the board.

“When cost differences are small, it comes down to such details as execution and performance—how well you manage the portfolio,” Martielli says. “Do you offer securities lending? What do you offer that goes beyond cost? We are seeing that dynamic play out on the larger end of the market. On the smaller end, clients are catching up.”

Mike Swan, client portfolio manager for defined contribution clients at SEI Institutional, also thinks the pendulum might be swinging away from over-concentration on low fees.

“Being solely focused on passive investments and reduced fees is shortsighted,” Swan says. “The focus needs to switch to value. For instance, we think 3(38) fiduciary services will be beneficial in the long term for most plan sponsors. It reduces the conflict in making investment decisions and allows plans to take action more quickly.”

Vanguard has also found that many of its plan sponsor clients are examining the glide paths of their TDFs to ensure they are the right solution for the demographics of their plan, Martielli says. To date, “there hasn’t been a significant difference between custom and off-the-shelf TDFs,” he says.

To that point, there is increased interest among sponsors for managed accounts from DCIO providers, says David Blanchett, head of retirement research at Morningstar. Indeed, Hartford Funds’ clients are increasingly asking about managed accounts, says Dave Hescheles, national sales manager.

“While the defined contribution market is still dominated by TDFs, sponsors are beginning to realize that plans can embrace the models of traditional wealth management,” Hescheles says. “The customization is what excites us—the ability to bring best-in-class managers to participants with very attractive prices.”

Likewise, more Voya Investment Management clients are seeking collective investment trusts (CITs), which used to only be available at the larger end of the market, says Mike DeFeo, managing director and head of DCIO. More sponsors also are inquiring about environmental, social and governance (ESG) investment, DeFeo adds.

“ESG is talked about more than utilized, but talk is starting to drive some action, as well,” he says.

A big development that is bound to affect the DCIO industry in the coming years—due to the massive amounts of Baby Boomers retiring and the passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act—is retirement income solutions, Brown says.

“While we have been talking about retirement income for 20 years, there really is a push now to figure out how to build income into products or deliver them as standalone in-plan offerings,” Brown says. “The SECURE Act has created opportunities for insurance wrap products to help participants hedge or minimize longevity and downside risk. This will be a clear way for DCIO providers to differentiate themselves.”

One recent example of such an offering was American Funds incorporating income into its TDFs, DeFeo notes. “More providers, including Voya, will be coming out with their own versions of that, including standalone retirement income offerings,” he adds. “Firms like Voya that have robust fixed income platforms are trying to figure out how to use that strength to provide unique investment opportunities in the market.”

Sponsors are increasingly interested in offering retirement income solutions, says Jordan Burgess, head of specialist field sales overseeing DCIO at Fidelity Institutional Asset Management. He notes that Fidelity’s annual Plan Sponsor Attitudes Survey has found that sponsors fear that 50% of their participants will not be able to cover essential expenses in retirement. This has also prompted 93% of sponsors to work with a financial adviser or investment professional, up from 70% in 2008, Burgess notes.

Moving forward, Voya is also exploring how to offer “access to private equity and other alternative levers and mechanisms that create wealth to retirement plan participants,” DeFeo says.

All in all, insiders point to a broadening of services by DCIO providers and a keener focus on the needs of participants and retirees.