Commingled funds will replace mutual funds in the largest defined contribution plans within the next few years, money managers predict.
The change will be the result of a tug of war between human resources and finance executives at plan sponsors a battle the financial executives are winning.
Commingled funds have gained in market share while mutual funds have declined, according to data from Hewitt Associates LLC, Lincolnshire, Ill. Hewitt found that 41% of defined contribution plans offered commingled funds in 2006, up from 32% in 2003. Retail mutual funds in DC plans, however, sank to 54% in 2006, from 65%.
Cynthia Hayes, managing director at Merrill Lynch Retirement Group, Pennington, N.J., said conversations with clients about commingled funds replacing mutual funds have increased significantly in recent months.
We were surprised at the level of dialogue from our largest DC clients. Theres been quite a bit more discussion from the finance side of the house than HR. (Finance executives) are more vocal in the replacement of mutual funds, Ms. Hayes said.
We will not have mutual funds in the majority of our DC plan clients within two years, she predicted. She declined to say how many clients have switched to commingled funds.
Commingled funds are attractive to those who run large DC plans because they can more easily negotiate fees and replace poor-performing managers.
The median expense ratio of a large-cap growth commingled fund is 56 basis points, compared with 93 basis points for a similar style mutual fund, according to data from Hewitt.
Many plan sponsors are replacing active managers with more passive strategies, or index-based investing. Plan sponsors have felt that its been difficult for them to replace a mutual fund manager in a specific asset class. It will be easier to replace a manager of a commingled fund, said Ms. Hayes.
Tug of war
Mark Friebel, senior vice president of asset allocation for Pyramis Global Advisors, Boston, Fidelity Investments institutional arm, agrees that commingled funds could surpass mutual funds in large DC plans.
What youre talking about is the very large end of the market, or the top 200 DC plans. And you see that there really is a tug of war between the HR and finance people. You have two camps, and I think the finance people completely understand the benefits of collective trusts (which include commingled funds). At some plans, the treasury people just have more pull, said Mr. Friebel.
For us, Pyramis is our institutional space (where commingled funds are offered) and Fidelity, as you know, is all about mutual funds. We want to satisfy both camps, he said.
Matt Smith, director of retirement services at Russell Investment Group, Tacoma, Wash., said the opportunity to cut fees is behind the interest in dropping mutual funds in favor of commingled funds.
One issue, he said, is that information for plan participants isnt as readily available in a commingled fund as it is in a mutual fund. Participants have to go to the record keeper or plan sponsor site for information, Mr. Smith said.
But he believes the choice of investment manager is more important than the structure of the fund. Choose the right manager first, Mr. Smith said.
Many investment managers have been adapting to satisfy both camps. The majority of bundled providers and investment-only providers offer both commingled and mutual funds.
What you have started to see with mutual fund managers, is that most see themselves as asset managers. They are expanding their firms capabilities, said Ms. Hayes. Merrill Lynch offers both kinds of funds to DC plans.
Douglas Murray, executive vice president at Wells Fargo Institutional Trust Services, San Francisco, said the firm manages $20 billion in commingled funds and just launched a new strategy for DC plans.
One of the styles that we were looking to launch is a large equity (commingled fund). Its been a very successful mutual fund and separate account, so now were doing a commingled version, he said.
But not all money management executives see commingled funds as a big deal.
Jeffrey Molitor, principal-institutional asset management at Vanguard Group, Malvern, Pa., said the movement to commingled funds is a lot more talk than reality.
Im not sure its a complete whimper, but its not a game-changing event. There are so many things behind mutual funds that keep them out front. The concept of brand remains very important in plan sponsors minds, said Mr. Molitor. Vanguard offers both commingled funds and mutual funds.
Cynthia Egan, president of T. Rowe Price Retirement Plan Services, Baltimore, said as plans get bigger, executives consider commingled funds but many decide against them.
I dont see an enormous trend in plans changing to collective trusts. Once a plan sponsor looks under the hood and does the evaluation, many see the upside to mutual funds, that they are more transparent to participants, said Ms. Egan.
T. Rowe Price offers both mutual funds and commingled funds to DC plans.
Commingled target date
Some money managers are beginning to offer commingled target-date funds in hopes clients will expand the relationship to later include core commingled funds.
Pyramis launched its target-date commingled fund in January. The strategy garnered $4 billion in nine months.
I think more plans will be adopting lifecycle funds that are collectives than mutual funds. Right now, Id say 90% of products out there are mutual fund-based and 10% are collective. Its a growing area, but we realize it will take time, said Pyramis Mr. Friebel.
He does not expect Fidelity Investments target-date funds, known as Freedom Funds, to suffer mass outflows as interest in commingled funds increases. Freedom Funds are targeted at smaller plans than commingled funds are, he said.
Among large defined contribution plans with commingled funds are Time Warner Inc., New York; International Paper Co., Stamford, Conn.; and Verizon Communications Inc., Stamford.
Time Warner offers 12 investment options in its $4.8 billion 401(k) plan, and a few of those are commingled funds, said Keith Cocozza, spokesman. He wouldnt elaborate but said commingled funds give participants more choice.
Robert Hunkeler, director of investments at International Paper, said officials at the $4.4 billion 401(k) plan have been believers in commingled funds for several years.
Its more cost effective for a plan of our size, said Mr. Hunkeler. All 10 of its investment options are structured as commingled funds.
All of Verizons 14 investment options in its $9.5 billion business and management 401(k) plans are separate accounts or commingled funds, said Michael Riak, director of Verizons savings plans.