Passive assets in DC plans spur 8.6% jump overall

Defined contribution plan money managers reported a surge in passive assets under management last year compared to 2015, according to Pensions & Investments' latest survey of these managers covering U.S. institutional tax-exempt assets.

Passive domestic equity assets climbed 14.3% to $1.24 trillion for the year ended Dec. 31, 2016, while passive domestic fixed income jumped 31.7% to $300.7 billion.

These numbers reflect internally managed assets, and they played the dominant role in overall internally managed assets rising 9.5% to $5.25 trillion in 2016 vs. 2015. Total DC assets under management gained 8.6% to $5.95 trillion during this period.

For both internally managed and overall DC assets, last year's gains reversed the slight declines in the previous survey covering 2015, when internally managed DC assets slipped by 0.9% and total DC assets fell by 1.1% from the 2014 figures.

DC consultants said they weren't surprised by the gains in passive domestic equity assets, noting plan sponsors and participants are embracing index funds for reasons that include disappointment with active managers, efforts to reduce fees and strategies of adding a passive equity component to complement an active equity offering.

"Participants want less expensive funds," said Martin Schmidt, principal at HS2 Benefits in Chicago. "They are asking for a more economical fund lineup."

The Department of Labor's rules on fee transparency plus fee-related lawsuits brought under the Employee Retirement Income Security Act have played a role in sponsors' actions, too, said Douglas M. Balsam, principal and director of institutional consulting for DiMeo Schneider & Associates LLC, Chicago.

"There's a greater feeling of comfort for the fiduciaries" when offering index funds, said Mr. Balsam, adding that sponsors are more willing to terminate an active manager that has struggled for several years to outperform benchmarks. Actively managed domestic equity assets fell by 2% to $1.32 trillion last year, according to the P&I survey.

Consultants were somewhat surprised by the P&I survey's report of a big gain in passive domestic fixed-income assets given the low-interest-rate environment.

"Our clients have a greater diversity of fixed income," said Mike Volo, a senior partner, based in Wellesley, Mass., at Cammack Retirement Group. "They are moving to inflation-protected securities and high yield. That's where we see clients' flows moving."

Although Mr. Volo expressed surprise at the gain in passive domestic fixed-income assets, he added that many participants will view such an investment as a "safe option."

Mr. Balsam surmised that the increase in domestic fixed-income AUM reflected sponsors' efforts to add a passive choice to an active one in their investment lineups.

"For most plans, we see their starting ​ point with an active fixed-income manager," he said. "What is being added more recently is a passive option to complement the active option."

Mr. Schmidt said he was surprised at the survey numbers. He said the percentage gain for domestic fixed income was more noticeable because the passive domestic fixed income asset total of $300.7 billion was dwarfed by the active domestic fixed-income total of $1.04 trillion in the P&I survey, up just 0.4% from 2015.

The greatest issue among sponsors for fixed-income investing is rising interest rates, a recent survey by T. Rowe Price Group Inc., Baltimore, found. Seventy-four percent of respondents told T. Rowe Price that was their biggest concern; low yields were mentioned by 17% as their biggest concern.

The survey of 54 sponsors found that a majority offered actively managed options in many fixed-income categories — stable value, money market funds, core-plus bond, global bond and unconstrained/absolute-return fixed income. These actively managed investments were stand-alone options or multistrategy white-label options in plans with assets of $500 million or more. The survey, by a firm that emphasizes actively managed investments, said sponsors favored passively managed options by a slim margin for Treasury inflation-protected securities.

In the P&I survey, international fixed-income investing suffered the biggest decline in AUM last year.

Passive global/international fixed income AUM was down 70.3% to $1.57 billion; and active global/international fixed income dropped 12.4% to $40.3 billion, among internally managed DC assets. They are by far the smallest categories among the passive and active investment strategies in the survey.

"I don't see much in the DC setting," said Mr. Balsam, referring to international bond options. "International markets have been out of favor for a long time," added Mr. Schmidt. "Sponsors aren't focused on international fixed income."

The P&I survey also found that actively managed international equity gained 0.8% to $395.8 billion, while passive international equity rose 3.6% to $213.5 billion.

In recent years, Mr. Schmidt said, "there haven't been a lot of good choices in international equity compared to domestic equity."

The P&I survey also found that for internally managed DC assets:

Target-date funds gained 10.1% to $993.7 billion;

Stable value rose by 2.5% to $443.3 billion; and

Treasury inflation-protected securities grew 5.9% to $39 billion.

Consultants also noted their experience matches P&I's findings among investment vehicles in which AUM for pooled/commingled funds and separate accounts were growing at a faster rate than for mutual funds. But mutual funds still account for most of the DC assets in the survey.

Defined contribution assets invested through mutual funds rose by 0.9% to $2.2 trillion last year; pooled/commingled funds gained 7.7% to $1.7 trillion; and separate accounts climbed by 12% to $1.1 trillion.

Predicting more plans will seek collective trusts and separate accounts, Mr. Volo said the trend is "clearly driven by a focus on fees."

Mr. Balsam said more large and midsize plans are offering collective trusts, adding that "the trend will continue." Greater use of collective trusts will be enhanced by providers lowering the minimum amounts in sponsors' plans that would make them eligible to use them, Mr. Balsam added.

The P&I survey also found Vanguard Group Inc., Malvern, Pa., dominated many of the asset categories. It was first in total DC assets, with $903.6 billion, 401(k) plan assets, 457 plan assets, profit-sharing assets, mutual fund assets, passive domestic equity, passive domestic fixed income, and real estate investment trusts.

The money manager with the next largest number of first-place asset categories was Nuveen, formerly listed as TIAA Global Asset Management, New York, which led in 403(b) assets, pooled/commingled vehicles, active domestic fixed income and real estate equity. BlackRock Inc., New York, which placed second in total DC assets with $692.3 billion, was the leader in the separate account and 401(a) asset categories.

Capital Group Cos. Inc., Los Angeles, led the active international equity and active global/international fixed-income categories. Capital Group's total assets of $293.4 billion was good for sixth place overall.