401(k) decumulation may impact money managers

A reversal in the dynamics in the 401(k) market will have major ramifications for money managers in terms of hanging onto or gaining defined contribution assets.

Cerulli Associates estimates that 401(k) plan aggregate withdrawals for the first time exceeded contributions in 2014. Distributions totaled $377 billion, while contributions were $338 billion.

“We think (2014 was) the first year for decumulation,” said Bing Waldert, director at Cerulli, a Boston-based asset management analytics firm, adding the firm is waiting for numbers for 2013 from the Department of Labor to confirm its estimate.

The change is expected to continue, and means 401(k) plans are “not going to be a guarantee of inflows anymore” for investment management firms, Mr. Waldert said.

A surge in older workers retiring along with a pickup in economic activity encouraging job changes is driving the new trend in net negative flows.

“You have some demographic pieces starting to play in,” including “older investors are starting to retire and … use their accumulated savings to fund their retirement,” Mr. Waldert said.

A J.P. Morgan Asset Management report, released in August, said the segment of the population crossing the 65-year-old threshold between 2014 and 2030 is projected to grow by 48%.

Adding to the negative outlook, the generation of 401(k) plan participants following retiring baby-boomers lags in wealth accumulation growth rates, the report said.

Cerulli estimates 401(k) plan assets totaled $4.7 trillion in 2014, Mr. Waldert said.

Justin R. White, New York-based partner at investment management consulting and research firm Casey Quirk & Associates LLC, said: “At a high level for the industry, defined contribution is not going to be a huge driver of organic growth in aggregate. However, because the way (plan participants) are investing within defined contribution is changing so much, there will be big winners in the defined contribution market.”

“It's a zero-sum game,” Mr. White added. “It's about takeaway vs. organic growth. Because of mainly (the growth of) target-date funds … there are meaningful opportunities. But for some firms, it won't be one of those (trends) where the tide kind of lifts all boats. There will be meaningful losers as a result of those changes as well.”

The negative net flows will lead to sponsors streamlining 401(k) menus and reducing fund choices, which will hurt managers offering traditional stand-alone portfolios but benefit firms hired for the remade, consolidated portfolios, Messrs. Waldert and White said. Increased allocations to target-date funds and passive strategies also will benefit managers running such platforms.

“There are still large pools of money to manage in this market and (that) still makes it a very attractive market for asset managers,” Mr. Waldert said. “Inflows into the market are increasingly going into target-date funds.”

Managers need to choose whether they'll participate in the target-date market, Mr. Waldert added. “Are they going to come out with their own product? Are they going to partner with a consultant who is building a (target-date) product? Are they going to look for strategic partnerships in an open architecture-style product?”

The trend “is a bit of a mixed bag for asset managers,” he said.

Investment managers most affected by the new trends “are those who aren't participating in the target-date fund market (and) try to go for individual (fund) mandates,” Mr. Waldert said. ”And managers who stand to lose aren't necessarily small managers,” but those not participating in target-date or passive management.

“If you go down a list of the largest target-date fund managers, they tend to be firms that also have record-keeping platforms,” Mr. Waldert said. Those include Vanguard Group Inc., FMR LLC's Fidelity Investments, and T. Rowe Price Group Inc.

“The target-date fund business has really been dominated by proprietary managers with their own record-keeping platforms,” he said.

Cerulli estimated that in 2014, 401(k) plans had 21% of their assets in target-date funds, Mr. Waldert said, with 46% of contributions going to the asset class.

A Vanguard report of its defined contribution clients through 2014 shows a steady growth in target-date allocations by participants. In aggregate, 97% of plans offered target-date funds, up from 90% in 2013. Participant allocations were in aggregate 50% of assets, up from 48% in 2013. Seventy-five percent of contributions were allocated to target-date funds, up from 74% in 2013.

“That is a very big driver of our continued growth,” said Emily White, Vanguard spokeswoman. “Target-date fund are a very significant part of this” change as well as index funds.

“In the defined contribution business, there is a changing landscape,” said Ms. White. Vanguard is addressing the challenges by working with plan sponsors on enhancing technology and plan design, including automatic enrollment and auto-escalation features, bolstering contributions, she said.

Vanguard, already a major target-date fund manager, earlier this year “announced an expansion of our target-date lineup,” Ms. White said in a follow-up e-mail. “We continuously seek opportunities to deliver economy of scale benefits,” including low cost funds.

The changing dynamics from negative net flows also is coinciding with a drive by plan sponsors to streamline investment options, Messrs. Waldert and White said.

“The old view of the best defined contribution plan was to offer as many options as possible,” Mr. White said. But that thinking has changed. “So you are seeing two things happening overall. One is the number of (fund) options are shrinking. … At the same time, the overall asset allocation to stand-alone portfolios is shrinking as participants allocate more assets into target-date funds.”

“So even in that stand-alone menu part of the market, which is shrinking overall because of consolidation happening within it, there are still going to be winners,” Mr. White said.

The big winner in the stand-alone sector will be passive managers as plans “offer broad indexes as the core menu option,” especially index funds, Mr. White said. “The other big winners will most likely be the core products from the well-branded, well-known organizations” with portfolio strategies that are traditional and not too aggressive, he said.

Messrs. Waldert and White also predict plan sponsors will re-evaluate their target-date funds as allocations continue to grow.

“We are already starting to see much more scrutiny of those products and we think that will continue,” Mr. White said. But he believes plan sponsors will continue to have typically only one target-date fund managers. “We don't foresee plans offering multiple target-date (managers). We see them more closely vetting the one they have.”

The decumulation phase will be the new normal for investment managers, Messrs. Waldert and White said.

“Right now we are projecting distributions (exceeding contributions) going forward,” Mr. Waldert said. “If the capital markets change, contributions and distributions could certainly change.”

But efforts by sponsors to hold on to assets of participants retiring or changing jobs rather than losing to rollovers into the retail market could help deflect the outflow in the long term. “So the idea of plan sponsors starting to act as sort of an asset accumulator is ... interesting,” Mr. White said.

“If the rollover pipeline freezes up and more of those assets stay in play, it really does change the competitive dynamic,” he added. Such a change would have “a pretty negative effect on the (retail) wealth market and will lead to higher growth rates in the defined contribution market.”

“If rollovers slow down and that leaky bucket goes from an annual gushing to a drip, that will have a meaningful effect on the overall growth rate of defined contribution,” Mr. White added.