BOSTON -- What would money managers do to keep their hands on half a trillion dollars? Not enough, according to a new report on the individual retirement account rollover market by Cerulli Associates Inc., Boston.
By 2010, $467 billion, or 9% of assets, will flow out of defined contribution plans into rollover IRAs, up from $127 billion in 1999, the report estimates. Thereafter, plan distributions will only get bigger as baby boomers retire and take their plan assets with them, according to the report, "The Rollover IRA Market: Retirement Markets in Transition."
Money managers currently aren't doing a great job of hanging on to the assets leaving defined contribution plans. Only 19% of rollover assets are retained by the 401(k) service provider, according to estimates in the Cerulli report. Even the 401(k) plan providers that make concerted efforts to attract participants at the time of rollover retain only 35% to 40% of DC assets they once managed. Most money managers aren't focused enough, or at all, on IRA rollover retention, contended Cerulli's consultants.
"The 401(k) market is an incubator market for the IRA market," said consultant Lisa Baird, the report's author. "But since on average, 401(k) plan providers are only keeping 20% of assets, the 401(k) market really ends up being an incubator for someone else's rollover program."
The consequences of inaction on IRA retention are significant. For the first time, assets invested in IRAs, pegged by Cerulli at $2.5 trillion, exceeded assets in defined benefit or defined contribution plans, pegged at $2.4 trillion and $2.2 trillion, respectively, for 1999. By 2010, defined contribution plan assets will hit about $7.2 billion, predict Cerulli consultants.
Chasing the market
Peter Starr, managing director at Cerulli, said: "Managers need to construct an IRA platform that's continuous in product and pricing to what was offered to the participant in the 401(k) plan. The rollover problem is parallel to managers' efforts to penetrate the high-net-worth market, but no one is really paying attention to this. And if you don't chase the rollover market, you will be in big trouble in a few years, especially if you are an institutional, investment-only manager."
Those full-service mutual fund companies with strong 401(k) and retail businesses and broker/dealers with scalable personal advice programs will be the big winners in the coming rollover race, while unbundled 401(k) plan vendors, investment-only money managers and third-party administrators will be the big losers, according to the report's prognosticators.
Contrary to popular belief, defined contribution plan participants with larger balances tend to roll over their lump sum distributions into IRAs. Cerulli's consultants found that 67% of assets distributed from defined contribution plans in 1999 were rolled into IRAs; 3% were transferred to new plans; 12% went out as benefit payments; and 18%, mainly smaller accounts, were taken as cash. When lump-sum plan distributions are sliced by number, rather than by total dollars, however, only 37% are rolled into IRAs.
Few platforms in place
Only one-third of 401(k) plan providers now have comprehensive IRA platforms in place to attract and serve IRA rollover business, said the report. Many other money managers now are developing strategies that likely will be implemented in the next six to 18 months.
One such manager is MFS Investment Management, Boston, which will spend $1 million at the end of this month on a marketing campaign to attract rollover business from its 14,000-plus top-producing third-party intermediaries that distribute its investment products. MFS expects its new focus on IRA rollover business to snare $1 billion in its first year from MFS 401(k) plan investors and those of other vendors, up from $400 million now, said Bruce Harrington, assistant vice president of the MFS IRA program.
Advice about how and what to invest in will be the differentiating factor, according to Cerulli consultants, especially as workers begin to walk away with large lump sums. Cerulli thinks broker/dealers and mutual fund companies each will capture 40% of the rollover market by 2010.
The need for advice, ranging from the most basic, electronically delivered forms to complex, handholding relationships, will push many IRA rollover candidates to broker/dealers, especially securities firms.
Direct-marketed mutual fund companies such as Fidelity Investments, the Vanguard Group of Investment Cos., American Century Investors, INVESCO Funds Group and T. Rowe Price Associates Inc. will attract the self-directed segment of rollover investors. Of these, Cerulli consultants said, Fidelity, Vanguard and T. Rowe Price have a distinct competitive advantage over other companies of their type. This is due to the depth of the advice and ease of service offered to rollover investors - a single phone call sets up the IRA for a departing DC plan participant. Banks, insurance companies and other providers will wage a heated battle for the remaining 20%.
Further dissecting categories of financial services companies, Cerulli consultants predict that no-load mutual funds and broker/dealer companies that "marry comprehensive 401(k) services with full-service retail capabilities" will have the greatest success both in retaining distributed 401(k) plan assets in rollover IRAs and attracting retail rollover business.
No-load mutual fund companies without high-touch 401(k) plan services will have to improve and increase the amount of advice they offer, the report suggests. Load mutual fund companies that sell to 401(k) plans through intermediaries will have a difficult time holding onto DC plan participants, because they won't be able to directly influence rollover decisions. Online brokerages such as E*TRADE and TD Warehouse also are pitching for a piece of the rollover pie and, lacking 401(k) plan services, may develop alliances with plan providers that lack good rollover platforms, predicted the report's authors.
None of the findings of the Cerulli report bode well for institutional and retail money managers that serve the 401(k) plan market with investment-only services or with outsourced 401(k) plan packages. These types of managers lack direct contact with plan participants and also lack access to simple personal information that would allow them to mail information about their services to a departing plan participant. Not all third-party record keepers are willing to share participant data, even for a fee, said the report's authors. Cerulli's report predicts that third-party administrators will almost completely miss out on the shift of assets to IRAs, with few ways to meaningfully replace lost record-keeping revenue.
Managers that lack access to defined contribution plan participants and robust retail mutual fund platforms - such as Barclays Global Investors NA, Deutsche Asset Management in the North Americas, United Asset Management Corp. and Capital Research & Management Co. - will, "in the short term, adhere to their strategy of increasing DC assets under management without concern for the coming rollover phenomenon. Their success at this will be driven primarily by performance. In the long term, however, if they wish to avoid a decline in asset growth, they will have to develop retail-oriented products or foster explicit links with retail providers."
Even money managers with retail mutual funds that are used frequently within 401(k) plan investment menus - among them Janus Capital Corp., Dodge & Cox and Neuberger Berman LLC - often lack more than "tangential" contact with participants, said the report, and no way to influence their rollover investment decisions. Performance is likely the only reason rollover IRA investors would keep their assets in a fund after rolling out of a 401(k) plan.
But participants accustomed to the low price of institutional mutual funds or commingled or separate account options in their 401(k) plans are likely to experience "a culture shock when he or she comes out of institutional pricing into the 1,500 basis point world of retail mutual funds," said Mr. Starr.
The report suggests the sticker shock of a retail stock fund with an average cost of 122 basis points - vs. 83 basis points for the institutional version - may persuade a growing number of plan participants to leave their assets in the defined contribution plans they left.