At the 2022 PLANSPONSOR National Conference in Orlando, Kathleen Kelly, managing partner, Compass Financial Partners LLC, told attendees of a session about defined contribution plan investment menus that her firm’s plan sponsor clients are increasingly “looking to us to enhance their retirement plan benefit to address needs related to the Great Resignation.”
Plan sponsors are asking what they can do to improve their retirement benefits to retain employees, she said. Among the solutions are fee compression, options to help do-it-yourself participants to build their own investment portfolios and good target-date funds for do-it-for-me investors.
Kelly said plan sponsors also often bring up decumulation solutions. “Sponsors are interested in how they can do better in letting employees know they care about them today and in the future,” she said. “Sponsors are thinking maybe they should be using their retirement plan as a tool to help long-tenured employees, and structure it to be a cradle-to-the-grave benefit.”
Kelly was among a panel of experts who spoke about trends in DC plan investment menus. Two trends discussed were the increasing use of collective investment trusts and the use of customized solutions.
Gene Huxhold, head of DCIO at John Hancock Investment Management, told conference attendees that asset managers expect that in the next five years, 50% of DC plan asset flows will be into CITs. He added that the No. 1 reason is price, as CITs are normally less expensive than similar mutual funds.
Lucian Marinescu, portfolio manager, head of target-date strategies, Morningstar Investment Management LLC, said CIT popularity is growing, especially in TDFs.
Another advantage of CITs, according to Huxhold, is they are not subject to retail investor reaction. “A number of years ago, a well-known investment manager, who had headed a fund for many years, retired, and when he did, the performance of the retail version of the fund dropped, but the CIT version didn’t,” he explained.
Huxhold noted that previously, onboarding with a CIT was complex and highly customized, so they were mainly adopted by mega plans. However, providers have found ways to simplify and investment minimums have come down, so smaller plan sponsors are able to adopt CITs. He added that they are still not permissible investments for 403(b) plans.
Huxhold warned that there is sometimes a deviation between a CIT and its comparable mutual fund performance, so when selecting CITs, plan sponsors want to check with the provider that returns are in line.
In addition to making sure CIT returns track similarly to their comparable mutual fund returns, plan sponsors should ask what oversight the CIT trustee has and look at whether the CIT is following the same strategy as its corresponding mutual fund and not deviating far from it, Kelly said.
Kelly said smaller plans should keep an eye on the threshold for when they will be able to switch to the CIT version of a fund. And plan sponsors shouldn’t necessarily assume a CIT is cheaper than the mutual fund version if the mutual fund version has revenue sharing that gets rebated, she added.
According to Huxhold, there is not a high demand for customized TDFs, although asset managers and plan sponsors are interested in how to provide a more customized benefit. “There are tools now that will take a handful of data points about participants to customize investment portfolios, but they are usually used for managed accounts—asset managers haven’t yet figured out how to translate them to TDFs,” he said.
Marinescu said custom TDFs make sense for large plan sponsors with their own investment committees and perhaps for plan sponsors that offer defined benefit plans, which would mean allocations should be different for their participants than the allocations in off-the-shelf funds.
Morningstar believes in the value of personalized advice, Marinescu said. He told conference attendees that available data from recordkeepers show that participants who are using managed accounts save 2% more on average for retirement.
“Plan sponsors need to do more than regular due diligence on managed account performance; they should look at the overall advice participants are getting,” Marinescu added. “For individuals with complicated financial situations or assets in other accounts, advice has value.”
Kelly said Compass Financial Partners believes managed accounts could be a valuable option alongside a TDF, but participants should not be defaulted into managed accounts because of their higher fees. “The benefit of managed accounts is realized when participants are willing to input data for full customization of investment allocations,” she said.
Some recordkeepers have just a single managed account option on their platform, but others have multiple solutions available, and “in the latter case, we do an RFI to select” the managed account, Kelly added. She said if a recordkeeper just puts a managed account on the lineup when a plan sponsor onboards with it, that is not a defendable reason to offer a managed account. Plan sponsors need to consider the usage by participants and whether fees are reasonable when they consider the benefits, not just the advice component.
“We do feel some people have complex situations and managed accounts would be a viable solution,” Kelly said. “We track what percentage of users of managed accounts that are paying these additional fees are optimizing customization.”
A Note About Inflation
On a final note, Kelly said that when Compass Financial Partners looks at the overall DC plan investment menu construction, it goes through a solid TDF selection process and includes a solid core lineup of actively managed funds and a suite of indexed strategies. “Beyond that, about seven or eight years ago, we started implementing real asset strategies with clients,” she said. “With TIPS [Treasury inflation-protected securities], REITs [real estate investment trusts] and commodities, we use a single fund-of-funds approach. The objective is inflation hedging. Many TDFs have real assets in their underlying strategies, so with this approach, participants have options to create their own strategy.”
Marinescu said that as inflation stays high, participants will reconsider their portfolios to hedge inflation. They’ll consider TIPS but also which asset classes will perform better in an inflationary environment. He said commodities are good for hedging inflation.
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