The latest research from Cerulli Associates, “U.S. Defined Contribution Distribution 2017,” outlines the various challenges and opportunities faced by defined contribution investment only (DCIO) service providers, as well as those faced by “boutique retirement plan consultancies.”
Speaking broadly, both groups are seeing strong and increasing demand for passive investment strategies from plan sponsors. Unfortunately, a lot of the passive momentum seems to be supported by the misunderstanding held by many plan sponsors that offering participants passive investment options absolves them of fiduciary responsibility.
“Despite significant efforts from consultants and asset managers seeking to dispel this misconception, it continues to exist,” Cerulli researchers warn. “Furthermore, demand for passive investment strategies is closely tied to the third-ranked challenge identified by asset managers—pressure on investment management fees.”
Choosing passive investments is a clear and simple way to reduce fees; however, choosing the fund with the cheapest expense ratio does not “equate to checking the fiduciary box,” Cerulli warns, as some plan fiduciaries mistakenly believe.
According to Cerulli, the bull market lasting nearly 10 years has also hurt active management as indexed strategies experienced strong returns. Related to this, Cerulli sees active managers focusing their sales resources on a subset of strategies that have strong, established track records in sub-asset classes that are not being targeted as “easy areas to go passive.”
Interesting to note, nearly one-third of DCIO service providers identify the $100 million up to $250 million plan asset segment as the greatest growth opportunity. Cerulli researchers say it is “striking how much interest is expressed in the segment,” more than twice the second-ranked segments of $25 million to $49.9 million and $50 million to $99.9 million.
“The midsized plan asset segment, and certainly this smaller component of it, is also representative of the DC market segment in which the boutique DC consultant is most prevalent and growing its market share,” Cerulli reports. “Asset managers seeking to work with these plans should have a holistic strategy in place for covering both national and regional boutique DC consultants. For example, they may choose to coordinate coverage between consultant relations and more retail-oriented groups focused on the broker/dealer and/or registered investment adviser channels.”
TDF market evolution in focus
Among other topics, the Cerulli analysis also examines evolution in the target-date fund (TDF) marketplace. As Cerulli researchers lay out, the TDF market remains highly competitive, and data shows that new entrants face challenges in winning mandates over more established products.
“This raises the question of why firms choose to launch additional target-date series. For example, some target-date managers have chosen to offer an additional ‘flavor’ of target-date fund investing in response to the current hyper-sensitive fee environment. Some firms with long-standing active target-date series have recently launched indexed or blended (using elements of both active and passive investing) target-date series to keep up with industry-wide demand for low-cost, passively managed investment products,” Cerulli explains.
One example cited by the firm is the launch in 3Q 2016 of a TDF that uses exchange-traded funds (ETFs) as the underlying investment vehicles. Other firms have taken the opposite approach by launching its equity-heavy and tactically managed TDFs.
“When comparing these two different series, differences in equity allocations can be greater than 30% depending on the point along the respective glide paths,” Cerulli concludes. “We encourages asset managers contemplating the launch of an additional target-date series to conduct a thorough assessment in regards to how a new potential series would be positioned relative to their existing target-date products. Will a new TDF help new segments of the DC market? What is the risk of a new target-date series cannibalizing asset flows from the existing target-date series?”
Information on obtaining Cerulli research is available here.