Data & Research October 4, 2023

Managed Accounts’ Default Use Limited by Litigation Fears, Fees

Plan advisers continue to pick TDFs in retirement plans, rather than more personalized managed accounts, in part due to legal concerns, finds Sway Research.

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New research shows that managed accounts are facing a stumbling block beyond fees and general acceptance in retirement plans: litigation fears.

Defaulting retirement participants into a managed account either immediately or after they reach a threshold of either age or assets, can offer a more personalized investment experience and potentially better outcomes. But retirement benefit consultants considering the option are often turned off not just by higher fees, but by litigation concerns, according to Sway Research’s most recent defined contribution investment only report.

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The research showed that “there’s a lot of concern around managed accounts and litigation risk, in addition to fees,” says Chris Brown, founder and principal of Sway Research, who surveyed 20 DCIO sales leads, as well as 207 retirement plan advisers and benefits consultants, in compiling the report.

When asked to rate the “level of litigation risk” for management accounts, 22% of plan advisers (those overseeing at least $10 million in plan assets) saw litigation risk as high or significant, with another 37% seeing it as unlikely, but agreeing that “concern is warranted,” according to the research. Those figures were higher for retirement benefit consultants (those overseeing on average $1.2 billion in plan assets), with 47% seeing high or significant risk, and 29% seeing it as unlikely, but still concerning.

Along with litigation concerns, the cost of managed accounts, as compared to TDFs, remains a stumbling block for many advisers as well, according to Sway.

When asked if adviser-managed accounts offered by Edelman Financial Engines and Morningstar are “too expensive” relative to TDFs, 43% of respondents either agreed or strongly agreed, with 39% neither agreeing or disagreeing and 18% disagreeing. Among retirement benefit consultants, those figures came in at 66% strongly agreeing or agreeing, 19% neither agreeing or disagreeing, and 15% either disagreeing or strongly disagreeing.

QDIA Resistance

Asked if they were offering managed account solutions as a qualified default investment alternative in at least one plan, 17% of advisers said they were, along with 19% of benefits consultants.

TDF use as a QDIA in a least one plan, however, dwarfed those usage figures. Third-party TDFs were the most likely to be used in at least one plan as the QDIA among plan advisers at 80%, followed by TDF portfolios from the plan’s recordkeeper at 64%. Those figures were 88% and 79%, respectively, from the benefit consultants.

Brown notes that despite DCIO providers working to show the benefits of managed accounts in DC plans, adviser concerns appear to be outweighing that push.

“They’re a good product for people that want them, and they are important products,” Brown says. “But for DCIOs, a lot of the hope for firms that don’t have a big target-date practice would be that [managed accounts] are used as a QDIA … but that is not happening.”

TDFs currently make up one-third of all DC assets, according to Sway’s estimates. Meanwhile, managed account providers Edelman Financial Engines and Morningstar made up about 4% of total DC market assets at the end of 2022, according to the firm.

“Managed accounts are gaining DC asset share, but the pace of these gains is miniscule relative to the size of the overall DC market,” the research firm wrote in the report.

A separate DC consulting study released by investment management firm PIMCO on Wednesday found skepticism among advisers that participants add enough personal data to fully utilize managed account tools. In a survey of 36 institutional consultant and aggregator firms, only 11% of advisers strongly agreed that participants “regularly add and keep current personal data in managed account tools.”

CITs Continue Down-Market

The Sway researchers did find one area of continued growth among DCIO providers: collective investment trusts. These pooled investments held by a bank or trust are only available for DC plans and are often cheaper and potentially more flexible than mutual funds.

Among 20 DCIO sales leads at asset managers surveyed by Sway, 20% noted gross sales from collective trusts, as opposed to just 8% in 2018. Meanwhile, 69% of sales are coming via mutual funds, as opposed to 83% five years ago.

The interest in CITs, which had initially been strong in large plans, has moved further down-market, according to Sway’s report. DCIOs estimated that 22% of current CIT-based sales are being generated by plans with less than $50 million of assets under management, and another 23% from plans between $50 million and $100 million.

The widespread push toward CITs, Brown notes, follows a consistent goal in recent years by DCIOs to lower expenses in DC plans. In this year’s report, 78% of asset managers noted fees as a top-five priority heading into 2024.

Here, too, litigation plays a role, as legal challenges often scrutinize fees charged to participants.

“A lot of [the litigation] may be targeting half-a-billion dollar plans,” Brown notes. “But people feel like everything works its way down, and soon it will come to smaller plans as well.”

Compliance October 4, 2023

Will ESOPs Finally Get Regulatory Clarity?

SECURE 2.0 requires DOL to create rules for ESOP valuation.

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One of the key obstacles to the creation of employee stock ownership plans is the lack of clear rules from the Department of Labor on private stock valuation.

ESOPs are employer-sponsored, tax-advantaged and ERISA-governed plans that provide company shares as part of employee compensation.

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A report published by Matrix Global Advisors on Tuesday stated that regulatory uncertainty “has a chilling effect on investment and innovation” because it makes it difficult to “assess risk.” Without clear regulatory guidance on how private equity should be valued, ESOP sponsors rely on court judgments and DOL enforcement actions as guidance for stock appraisal.

In this context of ambiguity, ESOPs are vulnerable to lawsuits because there are no clear rules for pricing such stock. This increases costs and risks and deters potential ESOP sponsors, according to the report.

Alex Brill, a senior research fellow at the American Enterprise Institute and the author of the report, says, “I think the regulatory uncertainty around ESOP valuation is a significant impediment for the industry, the most pressing concern right now.”

Michael Kreps, a principal in Groom Law Group, explains that public stock can easily be valued because it has a market price. Private equity does not have that benefit, but the appraisal industry has its own standardized methods for determining prices.

Kreps says the lack of effective rules from the DOL leaves industry actors asking, “Will the regulators accept their methodologies” of appraisal? The challenge for ESOPs, Kreps continues, is that they need to figure out “what the DOL can live with.”

According to Kreps, the DOL proposed a valuation rule in 1998, but that process was abandoned. In the meantime, DOL has “preferred not to tell us” what methods should be used and instead has relied on an approach of “we know when we see it, and when we don’t like it, we will deal with it through litigation.” This approach has a “destabilizing” influence on ESOP sponsors, Kreps says.

He says a new rule from the DOL “needs to focus on substance. We need to move past procedure.” Kreps wants the DOL to describe how to value different interests, some of which can be difficult to appraise, such as “control and appreciation rights,” as well regulatory risks.

The SECURE 2.0 Act of 2022 requires the DOL to create regulations for ESOP valuation, but no deadline was set. Brill said he hopes for a proposal in early 2024, and Kreps adds employee ownership has been a high priority for the administration of President Joe Biden, but he is unsure of when to expect a proposal.

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