Interest in managed accounts is low

Managed accounts are attracting only modest interest from defined contribution plan participants and executives.

Surveys show many DC plan consultants remain skeptical about managed accounts, relatively few participants use managed account services, and many plan executives prefer other qualified default investment alternatives, most notably target-date funds.

By the end of 2012, the top eight managed account firms had $107.9 billion in assets under management, less than 2% of the total $6.92 trillion in U.S. DC assets, according to Cerulli Associates, Boston.

“We see challenges” to managed account usage, said Kevin Chisholm, associate director at Cerulli. “Even if sponsors add it, will participants choose it?”

Consultants and managed account firm executives say participants most likely to use managed accounts are middle-aged or nearing retirement and with larger account balances, as well as those with sources of income outside the workplace.

“Their portfolios are getting complex,” said Sangeeta Moorjani, senior vice president of the professional services group of Fidelity Investments, Boston. “They have more sources of money, so they want more of an overall picture” of their financial health. Fidelity's managed accounts business had $5.6 billion in assets under management as of the first quarter of 2013.

Fidelity also offers target-date funds, but Ms. Moorjani said the two don't cannibalize each other's market share. “They coexist because one offers simplicity and the other offers personalization,” she said.

Most of Morningstar Inc.'s managed account clients also offer target-date funds. ”For sponsors, target-date funds are seen as a "safe' choice because they are very easy for participants to understand,” said James Smith, vice president for client solutions at Morningstar Investment Management, Chicago.

“Target-date funds don't address the bigger issues: Am I on track with my goal for retirement? And what is my goal?” Mr. Smith said. At the end of the first quarter, Morningstar's managed account business had $26.9 billion in assets under management, he said.

For Financial Engines Inc., “our sweet spot is (balances of) $50,000 to $300,000” with an average balance of $104,000, said Christopher Jones, chief investment officer of the Sunnyvale, Calif., firm that is the managed-account industry leader. “They can't get expert advice on the outside due to (the size of) their balances.”

Financial Engines' managed account business had $70.8 billion in assets under management as of March 31. It focuses on larger, more complex plans, such as those at companies with multiple matching policies, company stock, defined benefit plans and non-qualified plans, Mr. Jones said. Its average sponsor client has $1.23 billion in DC assets and 12,000 employees. And, 90% of clients also offer target-date funds.

Executives of managed account firms say the keys to greater growth are more plans offering them, the aging of the population, and a greater willingness by all participants to accept professional management for their retirement plan investments as well as outside income sources.

There are significant hurdles.

Among major DC consultants, 32% don't recommend managed accounts to their clients, according to an April survey by Pacific Investment Management Co. In the year-earlier survey, only 13% didn't recommend managed accounts.

“The consultant community has become less enamored with managed accounts,” said Stacy Schaus, executive vice president and defined contribution practice leader for Newport Beach, Calif.-based PIMCO, whose survey covered consultants working for plans with a combined $2.4 trillion in DC assets. “They are concerned about what you are getting for what's being paid.”

In the survey, consultants indicated they are most troubled about the cost of managed accounts (86% of respondents); the value of them vs. other default options (72%); the need for participants to provide more personal financial information than for other investments (48%); and the ability to measure participant success (38%).

Lori Lucas, the Chicago-based executive vice president and defined contribution practice leader for Callan Associates Inc., said comparing target-date fund fees and managed account fund fees “involves a lot of variables” such as a DC plan's assets and whether all participants are defaulted into the managed account.

The median target-date fund fee is about 75 basis points, while the “typical” managed account fee is 35 to 60 basis points, she said. However, the managed account fee “is on top of the investment fees of the underlying funds,” she added. For example, “if the weighted investment fees are 40 basis points, and the managed account fees are 50 basis points, the total fee would be 90 basis points for the managed account.”

Managed account providers acknowledge potential clients' concerns about costs, but they emphasize managed accounts add value through individualized treatment. “Although cost is always a key consideration for both companies and employees when choosing investments and services,” Fidelity's Ms. Moorjani said, it “is not an overarching barrier” to managed accounts.

Depending on the client, Fidelity will offer discounts based on participation rates or for a sponsor's use of managed accounts as a default option, she said.

Morningstar's fee “may be based on the balance in managed accounts with the basis-point fee being reduced as assets grow,” Mr. Smith said.

Financial Engines will offer discounts to sponsors based on certain enrollment benchmarks, Mr. Jones said. Managed-account-only fees range from 15 basis points to 60 basis points with an average of 39 basis points, he said. Financial Engines offers an “all-in” fee, averaging 55 basis points, that covers the managed account fee and underlying fund expenses, he said.

Although managed account company executives say business will improve if more plans use the option as a QDIA, DC plans have been slow to embrace it — and some are moving away from it.

Callan's annual surveys of DC executives in the past three years show a declining percentage of sponsors offering managed accounts as a default investment — 1.2% last year, 2.6% in 2011 and 7.2% in 2010. By contrast, use of target-date funds increased each year.

“Plan sponsors hesitate to use managed accounts as QDIAs because they know that in order to get the full benefit, DC participants must interact with the managed account (provider) by providing data about their unique situation — and that few will do so, especially in a default situation,” said Ms. Lucas. “If participants don't provide their unique data, then they are essentially paying for a tailored approach, while not fully benefiting from the tailored approach.”

The most recent annual survey by the Plan Sponsor Council of America, Chicago, reported that only 3.6% of DC plans offered professionally managed accounts as a default investment option for automatic deferrals. That compares with 69.7% for target-date funds, 13.4% for balanced funds and 10.6% for target-risk funds, according to the survey, which used 2011 data.

Participants remain much more willing to choose target-date funds, balanced funds and target risk funds than managed accounts, according to annual surveys by Vanguard Group Inc., Malvern, Pa., of what the firm calls “professionally managed allocations.”

A Vanguard survey published last month said 27% of participants among its record-keeping clients invested in a single target-date fund in 2012, up from 13% in 2008. Only 3% of Vanguard participants used a managed account program last year vs. 2% in 2008. Participants investing in a single target-risk or balanced fund last year represented 6% of Vanguard participants, down from 7% in 2008.

Although the percentage of participants choosing managed accounts has remained flat, more Vanguard record-keeping clients are offering managed accounts - 16% in 2012 vs. 8% in 2008.

Managed account executives say they expect plan officials and participants to become more comfortable with the option, especially as the experiences of the largest DC plans filter down. After all, the largest managed account firms' AUM have had compounded annual growth rates ranging from 10.2% to 40.9% over the past two years. “There is a lot of room in the marketplace,” said Ms. Moorjani.