Custodians see growth coming from DC plans

Some big global custodians, whose traditional retirement business has come from defined benefit plans, are now getting business from defined contribution plans.

Leveraging relationships they already have through clients' DB plans, custody banks are being hired by executives at larger defined contribution plans that offer customized investment options. The banks are providing fund accounting and valuation that were traditionally handled by record keepers for mostly mutual funds and other off-the-shelf investments.

The growth in DC plans' use of unitized, or blended, options structured as separate accounts or collective trusts — where multiple managers run one investment option — has made such fund accounting too complex for most record keepers, thus attracting the interest of big global custodians like Northern Trust, State Street and BNY Mellon.

Just as DC plans have to have scale in order to unitize or otherwise customize options, so custodians vying for that business have to have the scale to provide the services, said Sue Walton, senior managing director at Towers Watson & Co., Chicago.

“It's the evolution of what we've seen in the defined contribution industry,” said Ms. Walton. “Almost all the plans I work with have customized funds, and they're moving away from bundled services as customization increases.”

Custodians, while not directly selecting the managers used in customized DC options, want to be involved when those options are being created, said Serge Boccassini, senior vice president, institutional product management, at Northern Trust Corp., Chicago. “We like to be in at the beginning,” Mr. Boccassini said. “We do want to know how (DC sponsors) want us to administer the fund options.”

All three major custodians have seen increases in their DC assets under administration within the past two years. At State Street Corp., AUA increased $70 billion during the past 12 months to a total of $500 billion, while at Bank of New York Mellon Corp., DC assets under custody and administration have hit $276 billion, up 10.3% from Jan. 1, 2012. At Northern Trust, DC AUA reached $225 billion, up 10% from the start of 2012.

Those assets should continue to increase if a trend noted by the latest Callan DC survey is sustained. According to the survey of DC plans, 14.9% of DC plans offered unitized investment options in 2012 vs. 6.9% in 2010.

Firms with both defined benefit and defined contribution plans can save money by using the same custodian and money managers for both plans.

Also, companies with only DC plans — those with $2 billion or more in assets — can offer more streamlined and diversified investment options that can have changing components without the time-consuming and costly disclosure and regulatory requirements that come with replacing one option with another, said James Veneruso, vice president, fund sponsor consulting, at Callan Associates Inc., Chicago.

“There may be substantial savings on investment management fees” in such a customized multimanager structure, he said. “These savings could then outweigh the cost of custodial services to unitize the underlying managers into one fund.”

At Northern Trust, custodial and all other plan fees can come from customized funds by including them in the net asset value calculation. Mr. Boccassini said.

Mr. Boccassini said Northern Trust also will work with DC plans that use a manager-of-managers approach — and their record keepers — to help select managers for customized options. Often, Northern's affiliate, Northern Trust Global Advisors Inc., is used.

Kerry White, Boston-based managing director of product commercialization for BNY Mellon Asset Servicing, said DC clients are finding “there's a lot more math” they need to concern themselves with, particularly with fee disclosure, that had been part of what bundled providers offered in their off-the-shelf investment options. “Now they recognize that with open architecture, nothing's really free” and they're willing to use external custodians.

She said one of BNY Mellon's larger DC clients, a technology company with “very well-educated and sophisticated employees,” created customized active equity and fixed-income options along with customized target-date funds for which BNY Mellon provides daily valuation and fund administration.

The three trends driving the move to customized options — fee transparency, unbundling and investment option sophistication — have also driven DC providers and even traditional record keepers to global custodians, said Rebecca Schechter, senior vice president of institutional investor services at State Street in Boston.

“Independent custodians are pairing up with a record keeper,” Ms. Schechter said. “Some DC plans are also offering separately managed options, and we're seeing business in that as well. Both are variations on a theme of increasingly sophisticated investments for participants. We play in the semibundled space with separately managed options.” Of State Street's DC custodial clients, 115 are plan sponsors (including those with both DC and DB plans) and 13 are record keepers.

State Street provides custodial services for the customized investment options offered by the $9.2 billion 401(k) plan at Intel Corp., Santa Clara, Calif., and the two 401(k) plans at United Technologies Corp., Hartford, Conn., with a combined $20.3 billion in assets. Intel offers hedge fund investments as part of its customized target-date options “which are complex to rebalance and value,” Ms. Schechter said.

Sources also said Northern Trust, as global custodian for the defined benefit plans at Chrysler Group LLC, Auburn Hills, Mich., provides daily NAV for customized options in the automaker's $4.1 billion Defined Contribution Master Trust 401(k) plan. Officials at Chrysler would not comment, and Mr. Boccassini and John O'Connell, Northern Trust spokesman, said the firm doesn't comment on its clients.