Popularity of core funds in DC plans is waning, Cerulli says

Defined contribution plan designs emphasizing core equity and fixed-income investment options will become less popular as more plan executives deem the strategy inefficient and as target-date funds take a bigger piece of the pie, according to a new report by Cerulli Associates, Boston.

Core options' “days in defined contribution plan design are numbered,” even though they will continue to represent the biggest element of plan design for years to come, the report said.

Cerulli predicts allocations to core strategies will drop steadily to 50.3% in 2016 from 60.9% last year.

Target-date fund allocations will climb steadily to 22.9% from 12.3% during the period. Other investment categories are expected to remain constant — stable value/money market at 15%; company stock at 5.9%; target-risk funds at 3.5%; and self-directed brokerage accounts at 2.5%.

Offering core options in a tiered system represents a compromise between participants who prefer a target-date approach and a small group of more aggressive investors using a brokerage account, the report said. “But Cerulli does not believe that the compromise investor exists,” said the report.

Kevin Chisholm, senior analyst at Cerulli and author of the report, said in an interview that plan executives realize creating an optimal portfolio based on core options “is challenging for participants.”

Mr. Chisholm said the retirement industry has been slower than the rest of the asset management industry in offering comprehensive portfolio solutions. “A lot is being thrown at sponsors,” he said. “They have other benefits to consider, and health care is a bigger concern.”

The DC industry “still offers funds to employees without knowing, and in many cases without considering, how the fund fits into a portfolio,” the report said. “Participants have been left with a menu of choices that are highly correlated and suboptimal.”

Among its other findings, the Cerulli report said:

• A large percentage of DC plan executives is evaluating stable value options, but Cerulli predicted relatively few changes because the alternatives, such as money market funds and short-term bond funds, are comparatively unattractive.


• A large percentage is reviewing record-keeping arrangements, but Cerulli forecast that most of the reviews represent checking costs of competing providers, rather than planning to switch.


• Retirement income products remain a topic of discussion, but only a small percentage of plans will add them in the next two years.


• Collective trusts, which are touted as a cheaper way of doing business for many sponsors, won't be as attractive as many industry experts have predicted.

The Cerulli report said 21% of plan officials expect to change stable value providers in the next two years, while 22.6% said they wouldn't change. Those most likely to change were plans with assets of $250 million to $500 million, followed by plans with assets exceeding $5 billion.

However, 42.7% of all respondents said they weren't sure and are reviewing their current stable value investments.

“There's a lot of talk but not much action,” Mr. Chisholm said. “Plan sponsors are reviewing their current offerings but they're also asking, "'What are the alternatives?' The money market funds aren't paying anything. Do you offer a short-term bond fund? There's not a lot of great alternatives in the near term.”

Only 7.7% of plans said they would be switching to a money market fund from a stable value fund during the next two years, while 4.4% said they would make some other undefined change.

Plan executives also are talking a lot about record keepers, but most are staying with their current providers, Mr. Chisholm said. “Cost concerns are permeating the industry” and the new and pending fee-disclosure regulations from the Labor Department will prompt more record-keeping searches, he said. However, most of the searches will be solely to conduct pricing comparisons.

“This makes it tough for record keepers” that respond to sponsor RFPs, Mr. Chisholm said. “They wonder if the plan sponsors are just kicking the tires. But they have to go all out (in their presentations) for all of them.”

The Cerulli report found that 41.9% of plan executives expect to conduct a record-keeper search in the next two years for comparing prices, while 13.4% will issue an RFP to change record keepers. Funds most likely to change record keepers have assets between $250 million and $500 million while the least likely to change is a plan with assets of more than $5 billion.

Multiple questions characterized plan officials' views of retirement income strategies, and the bottom line is that only 7.8% said they would be adding such an option in the next two years. “The products are still very new, and there are fiduciary concerns,” Mr. Chisholm said.

Plans most willing to add a retirement income strategy were those with assets between $500 million and $1 billion. The Cerulli report found that 28.2% of all plans won't add a retirement income strategy and that 70% were not sure.

Plan executives aren't even sure what constitutes a retirement income strategy. They offered seven different descriptions, ranging from annuities embedded within a 401(k) to stable value funds to managed accounts with an option to purchase an annuity.

The Cerulli report also noted that collective trusts may not be as popular as proponents had hoped. Used often by the largest plans, collective trusts are viewed as a way to cut fees.

However, when Cerulli asked plan executives about their preferred investment vehicle, 22% cited collective trusts while 33.1% mentioned mutual funds and 14.7% identified separate accounts. Another 30.2% said they used a mixed approach, adding that the investment vehicle was secondary to selecting a manager and the manager's strategy.

Even the largest plans aren't flocking to collective trusts. The Cerulli report said that when given a choice, only 15% of plans with assets exceeding $5 billion preferred collective trusts vs. 20% for separate accounts, 35% for mutual funds and 30% for a mixed approach relying on the investment manager.

Cerulli's report is based on an online survey of 251 DC plan executives whose plans have assets exceeding $250 million, as well on telephone interviews with 30 asset managers, consultants and record keepers. n