The skyrocketing growth of mutual funds as the preferred investment vehicle for defined contribution assets appears to have slowed, according to Pensions & Investments' directory of defined contribution money managers.
At year-end 1998, assets invested in mutual funds were up just 16% -- to $640.4 billion from $554.2 billion -- from the year before. By comparison, the previous year's survey showed the mutual fund share of the defined contribution asset pie had increased 66% during 1997. And for the first time in the past decade, growth in mutual funds fell behind the growth of assets invested in separate accounts, which rose by 17%.
Still, plan participants invest far more of their defined contribution assets in mutual funds than in separate accounts. As of Jan. 1, 36% of the $1.79 billion in total defined contribution assets managed internally by the 288 firms surveyed was in mutual funds, while separate accounts held 13%.
Overall, the defined contribution assets of the firms surveyed increased 18% in 1998.
Undeniable advantage
Mutual funds have an undeniable advantage over other investment vehicles for plan participants including name recognition and easy access to fund performance information, said Paul Greening, vice president of Sheppard Associates Inc., a Glendale, Calif., consulting firm.
Employees know the name-brand mutual funds because they are so heavily advertised in the popular media, he said.
Separate accounts, he said, are "harder to explain to employees."
However, many administrators and consultants are far from sold on mutual funds as the investment vehicle of choice.
"The problem with mutual funds is style drift," said Don M. Faller, president of CBI Business Service Inc., Orlando, Fla., a third-party administrator. "A lot of medium-and small-cap funds that we selected within the last 12 to 18 months have drifted to medium-and large-cap."
Alternative nuances
Alternative investment vehicles such as separate accounts and collective trusts are lower cost and must stay to a stated investment style, Mr. Faller explained.
But it takes a sophisticated plan sponsor to understand the nuances of alternate investment vehicles and one that is willing to take on the extra burden of explaining those vehicles to employees, he added.
Money managers that offer separate accounts and other non-mutual fund vehicles still have to "get over the hump of the name brand," he said.
One manager that presented a strong showing this year was Barclays Global Investors, San Francisco, which gained $20 billion in internally managed defined contribution assets from the year before. The majority of those assets are in separate accounts and commingled accounts other than mutual funds.
With the boom in technology and increasing use of Internet and intranet Web sites, managers with non-mutual fund options will be able to provide participants with daily pricing, said Rich G. Malconian, chief executive officer of Barclays' U.S. defined contribution business.
"Technology is the enabler allowing the trend toward separate and commingled accounts to accelerate," Mr. Malconian said.
But the "tide will change with investment philosophy" of the plan sponsor, he said.
Also fueling the growth at Barclays was a change in marketing strategy, Mr. Malconian said.
In the past, defined contribution was a "legacy business" that the company did not actively pursue. When Mr. Malconian joined Barclays from Fidelity Investments, Boston, in October, he came with a mission to develop the company's defined contribution business, he said.
Once again, the majority of the top 10 managers in this year's P&I survey are mutual fund groups.
The findings of P&I's survey reflect the broader trend. While mutual funds are still the dominant managers of 401(k) assets, their market share for the first time remained stagnant at 42% in 1997 and 1998, according to studies by Spectrem Group, Windsor, Conn. This is the first bump in the steady growth in market share mutual fund companies have experienced since 1991 when they held 21% of the market. Comparatively, banks had about 20% of the market since 1998, down from 27% in 1992 and insurance companies held firm at 22% of the market, the same market share it had the year before but down from the 37% share they had in 1992, according to Spectrem.
In the P&I survey, once again most of the assets are concentrated in the top managers. As in past years, the top 25 managers invested close to 80% of the roughly $1.8 trillion reported by the 288 money managers as of Jan. 1. More than half of the assets -- about 58% -- were run by the top 10 managers.
And, as in past years, 401(k) plans held the most in defined contribution assets, accounting for about $843 billion of the assets.
There are no major changes from the previous year in the managers that made the 1998 top 10. The top three managers remained the same as last year, each realizing a significant jump in assets from the year before. Fidelity Investments' internally managed defined contribution assets rose 29%; the Teachers Insurance and Annuity Association -- College Retirement Equities Fund, New York, increased 15%; and State Street Global Advisors, Boston, 49%.
Merrill Lynch & Co. Inc., Plainsboro, N.J., dropped to 10th place from fourth with close to a 1% drop in assets. A spokeswoman said the slight drop in assets was due to market conditions and fund inflows.
With an increase in assets of a bit more than $4 billion, about 11%, from the year before, Capital Research & Management Co., Los Angeles, moved up to eighth place from 10th, bumping Metropolitan Life Insurance Co., New York, to ninth. MetLife reported $40 billion in 1998, about 1% more than it had reported in 1997.
Open architecture
P&I's survey also revealed the move toward the so-called "open architecture" worked to the advantage of several investment-only managers in 1998. Under an open architecture strategy, a bundled defined contribution provider will offer investment options by outside money managers in addition to their own funds.
Pacific Investment Management Co., Newport Beach, Calif., experienced a growth of 16%, or about $3.5 billion in defined contribution assets in 1998, largely because of the increase in open architecture, said Greg Bishop, vice president.
"We made a decision not to get into the bundled 401(k) business, and it has been a good move for us," he said.
Active stable-value popular
The company's biggest sellers have included its actively managed stable-value offerings, which account for about $7 billion of the $12.8 billion PIMCO reported for 1998, Mr. Bishop said.
While allocations overall to the stable-value asset class have not risen significantly, there has been a shift toward these actively managed options within the stable-value portfolio, Mr. Bishop explained.
"The concepts of bundled and unbundled are not clearly distinct anymore," said Ruth Hughes-Guden, principal with Morgan Stanley Dean Witter Investment Management Co., New York. "Those lines are very blurred."
Morgan Stanley Dean Witter reported $14.5 billion in defined contribution assets under internal management, up 61% from $5.5 billion the year before. Like PIMCO, Morgan Stanley is an investment-only manager and does not offer bundled services, Ms. Hughes-Guden said.
Although Franklin Templeton offers bundled services in the small plan market, it does not in the mid and large plan markets. Instead, company executives attribute the majority of its roughly 15% growth in 1998 to being included in other managers' bundles of fund options.
However, Denman Zirkle, executive vice president of institutional marketing, said he thinks the growth in this area will start to slow.
"I think the pure alliance business is definitely maturing. We will not see the rates of growth we have seen in the past," Mr. Zirkle said. "Although there will be nice growth in expanding relationships with (existing) alliance partners."
Already, company executives are building subadvisory relationships with 401(k) alliance partners, Mr. Zirkle said.
Technology helps
Technology is making it easier for managers to provide multiple funds beyond just their own, said Donald Salama, vice president and director of retirement plans for Hartford Life Insurance Cos., Simsbury, Conn.
In the small 401(k) plan market, there is a trend toward making outside funds more expensive than internal funds, Mr. Salama said.
"But the (plan sponsor) demand is there," he added.
However, inclusion in a bundled provider's menu of investment options carries a cost for the outside manager. PIMCO has set up a share class of its mutual fund to provide a 25 basis point 12b-1 fee to cover bundled providers' record keeping and other expenses, Mr. Bishop said.
Morgan Stanley has had to pay between 25 and 30 basis points to offset the bundled providers' record keeping costs and loss of revenue that otherwise would be invested in the bundled providers' proprietary funds, said Ms. Hughes-Guden.
Part of the reason for the trend toward including other managers' funds in a bundled plan is that plan sponsors are seeking a greater number of money managers across asset classes, said A. Chris Scibelli, director of marketing for Metropolitan West Asset Management, Los Angeles.
"They like to have flexibility across money managers," he said.
And plan sponsors are not as wedded to name brand funds as before, he said.
"I think the marketplace has matured to the point that plan sponsors see that the brand name fund may not always be the best for the firm," he said.
An expected trend that did not materialize in 1998 was more movement toward self-directed accounts, said Mr. Greening of Sheppard.
Few offer self-direction
According to The Society of Plan Sponsors' DC/401(k) Benchmark Survey, only 10% of plan sponsors with more than 500 employees offer self-directed brokerage accounts and none of the smaller companies offer them. Of those that offer the accounts, only 5% of plan participants actually use them, the survey stated.
There are a couple of reasons, Mr. Greening explained. One is that it is more costly to enter into that type of relationship. The other is that plan sponsors are concerned about employee education and additional employer fiduciary liability.
Plan sponsors with self-directed brokerage accounts have to "put total faith in employees to select their own funds" instead of allowing participants to choose among a set of carefully selected investment options, he said.
"You do not have that security if you turn the employee loose and the employee can pick any publicly traded investment."
