Passive Strategies on the Rise

The availability and usage of passive strategies among defined contribution plan investments rose over the last decade, in core menus and target-date funds alike, according to a new analysis from the Defined Contribution Institutional Investment Association’s Retirement Research Center.

While there was a notable shift to passive strategies over the period, the magnitude of the change varied considerably by asset class, according to the paper by David Blanchett of PGIM and Spencer Look of the Morningstar Center for Retirement and Policy Studies.

The category of funds with the greatest change over the decade was growth-and-value-blended small-cap equities, where 21% of funds were active in 2023, down from 65% in 2013—a reduction of approximately 4.4 percentage points per year. Meanwhile, the changes in other asset classes were more muted: High-yield bond, intermediate core-plus bond, international growth equity and international value still had at least 90% of funds actively managed as of 2023. Within U.S. equity strategies, growth and value had significantly higher shares of active compared with blend, which had the most sizeable move to passive over the decade.

In addition, while larger plans were much more likely to be using passive strategies in growth-and-value-blended funds in 2013, the overall gap between active and passive utilization across plan sizes narrowed and fell over the period. For example, in 2013 the average active composition in blended funds ranged between 26% among the largest plans and 55% for the smallest plans, while by 2023, the range was between 15% for large plans and 17% for the largest plans and 19% for the smallest plans.

DCIIA research from earlier this year showed that TDFs have become the predominant defined contribution asset class selection, as allocations increased by roughly 2.5 percentage points per year over 11 years, to approximately 50% of total DC plan assets in 2023 from about 24% in 2013.

The most recent DCIIA paper revealed that among TDFs, passive strategies were chipping away at active ones: the total percentage of 401(k) plans in the analysis that used active TDFs declined to less than 50% in 2023 from approximately 80% in 2013. The decline in use of active TDFs was greatest among smaller plans, while the share of mega plans (defined as those having assets greater than $500 million) using active strategies remained relatively flat.

The authors noted that Morningstar, which provided the data for the analysis, considers all TDF series to be actively managed, since portfolio managers make asset allocation and glide path decisions. It uses active and passive to describe series’ underlying holdings. A series is considered passive if more than 75% of its assets are in index funds, whereas those with less than 25% of assets in index funds are deemed active. Those with between 25% and 75% of assets in index funds are considered blend offerings.

According to the figures from 2023, when the share of plan assets in TDFs went up, the odds of using an active TDF strategy went down for micro plans (between $1 million and $4.99 million total assets), small ($5 million to $24.99 million) and midsize ($25 million to $249.99 million) plans. However, the opposite was true for large ($250 million to $499.99 million) and mega plans. The authors wrote that “it is not clear why this is reversed for large and mega plans.”

The data for the analysis were obtained from Morningstar and were based on Form 5500 filings from 2013 through 2023.