Target-date funds the engine powering continued growth

Defined contribution money managers reported a large jump in target-date assets under management to $1.44 trillion as of Dec. 31, up 30.5% from the end of 2016, according to Pensions & Investments' annual survey.

While the previous year's survey also showed double-digit growth, target-date assets were up only 10.1% in the year ended Dec. 31, 2016.

Consultants cited target-date strategies' prominence as default investment options, the increased use of auto features, and positive market returns in 2017 as contributors to those funds' growth.

"As the primary default investment vehicle for DC plans, (target-date funds) are getting upward of 50% of new assets," said David O'Meara, New York-based senior investment consultant at Willis Towers Watson PLC.

"Now that they've been instituted for 10 or more years in a lot of plans ... it's not just the very youngest and lower-earning population (that are exposed to target-date funds). It's a pretty broad group of the plan demographics," he added.

The target-date numbers helped boost managers' overall internally managed assets to $6.18 trillion as of Dec. 31, up 15.9% from the end of 2016. During the same period, total DC assets under management rose 17.4% to $7.09 trillion.

Managers' custom target-date assets also grew by double-digits in 2017 to $138.44 billion, up 30.4% from 2016. In 2014 and 2012, managers' custom target-date assets totaled $87.69 and $27.46 billion, respectively.

Along with the growth in target-date assets, the current survey found an increase in managers' passive AUM.

Among internally managed assets, passive domestic equity assets rose 27.7% to $1.59 trillion as of Dec. 31, while passive domestic fixed income increased 18.5% to $356.7 billion. The previous year's survey also showed double-digit growth in passive domestic equity and passive domestic bonds.

Active domestic equity climbed 15.7% to $1.68 trillion as of Dec. 31, while active domestic fixed income declined 6.2% to $1.06 trillion.

Mr. O'Meara said Willis Towers Watson clients are asking "a lot" about whether they should offer more passive options to their participants, with some clients deciding to add more passive domestic and international equity options as well as passive domestic fixed-income options.

For participants, the opportunity to get cheap access to market beta through index funds is attractive, he added.

Scott Matheson, managing director, defined contribution practice leader at CAPTRUST Financial Advisors in Raleigh, N.C., said his firm also has seen more passive options being added.

Liana Magner, Boston-based U.S. defined contribution and financial wellness leader at Mercer LLC, said among the firm's large plan clients, 20% of participant assets are allocated to stand-alone active domestic equity strategies and 18% are invested in stand-alone passive domestic equity strategies.

According to a separate Mercer survey of 68 off-the-shelf target-date mutual fund and collective investment trust series with $1.7 trillion in combined assets, passive strategies were the most popular target-date type, capturing 51.8% of target-date assets as of Dec. 31, while active strategies captured 36.8%, and passive/active strategies, 11.4%.

The current P&I survey also found a 12.2% decline in stable value assets to $391.33 billion at the end of December.

Mr. O'Meara said the firm has seen a gradual decline in stable value's prominence over the last several years.

Stable value funds were once a popular default investment option, but now target-date funds "dominate as the preferred qualified default investment alternative," he explained. Additionally, many of the stable value investors are older and drawing down their assets, often contributing to net cash outflows from those funds, he said.

Another explanation offered by Michael Volo, senior partner at Cammack Retirement Group Inc., in Wellesley, Mass., was that the long-term bull market has perhaps led some investors to become more aggressive and reallocate their stable value holdings to equities.

The current survey found an increase in global fixed-income AUM, reversing declines in the survey covering 2016.

Passive global/international fixed-income assets increased 61.6% to $2.49 billion as of Dec. 31, while active global/international fixed income rose 21% to $51 billion.

Mr. Volo said he suspected last year's increase was driven, in part, by participants allocating more to active and passive global fixed-income strategies due to strong market performance. Additionally, more plan sponsors are "adding global fixed income to their investment menus in an effort to offer a higher-yielding fixed-income option that offers diversification from U.S. rates and the potential for higher returns," he said.

Ms. Magner said the firm's clients tend to offer global fixed income and niche fixed-income strategies such as emerging markets debt, high-yield fixed income, and multiasset credit within custom target-date portfolios as opposed to in stand-alone options.

The majority of DC managers' AUM continues to be concentrated in mutual funds, although other pooled/commingled funds and separate accounts have been growing in popularity.

In the current survey, the amount of assets reported in mutual funds rose 16.7% to $2.77 trillion as of Dec. 31. Over the same period, assets in pooled/commingled vehicles grew 16.4% to $2.04 trillion and separate accounts jumped 7.6% to $1.23 trillion.

Mr. O'Meara said the potential for cost savings make commingled vehicles attractive.

There is the potential for lower trading costs within commingled vehicles, and sometimes investment managers will give a fee break to institutional clients, especially ones of a certain size, which they can't do in a mutual fund, he explained.

"You're seeing money managers pretty aggressively offering collectives with very, very low minimums," which would enable more plan sponsors to use them, CAPTRUST's Mr. Matheson said, adding that the most common adopters among DC plans are 401(k) plans as only a "select subset" of 403(b) plans are permitted to use collective investment trusts.

While the amount of assets managers in the survey run for 401(k) plans has increased sharply in the past 20 years, assets in 403(b) and 457 plans have remained relatively stagnant.

In the current survey, managers' internally managed assets in 401(k) plans totaled $3.9 trillion as of Dec. 31, up from $2.1 trillion in 2012, $1.68 trillion in 2007, $1 trillion in 2002 and $714 billion in 1997. Meanwhile, 403(b) plan assets totaled $573.7 billion as of Dec. 31, compared to $566 billion in 2012, $606 billion in 2007, $383 billion in 2002 and $295 billion in 1997. Internally managed 457 plan assets reached $107 billion as of Dec. 31, up from $78 billion in 2012, $61 billion in 2007, $42 billion in 2002 and $44 billion in 1997.

Consultants pointed to the size of the entities sponsoring 403(b) and 457 plans vs. 401(k) plans, along with role of 457 plans as supplemental retirement plans, as possible reasons for the stark contrast between the growth in 401(k) plans and non-401(k) defined contribution plans.

"While there may be new formation of non-profits, they often start small and stay small," Mr. Volo said.

Individual manager rankings for the 10 largest DC managers remained unchanged year-over-year.

Vanguard Group Inc., continued to rank first in total DC assets, with $1.14 trillion as of Dec. 31, making it the first manager to pass the $1 trillion threshold.

The Malvern, Pa.-based firm also continues to rank first in internally managed DC assets with $998.8 billion in 401(k) plan assets, profit-sharing assets, 457 plan assets, mutual fund assets, passive domestic equity, passive domestic fixed income, and real estate investment trusts, according to the current survey. (The plan type and investment strategy rankings are also based on internally managed assets.)

Nuveen, New York, which ranked fourth in total DC assets with $533.2 billion as of Dec. 31, continues to rank first in 403(b) assets, pooled/commingled vehicles and active domestic fixed income.

BlackRock Inc., New York, which placed second in total DC assets with $855.1 billion, remains the leader of separate accounts and 401(a) plan assets.

Capital Group Cos. Inc., Los Angeles, which ranked sixth in total DC assets with $372.9 billion, continues to lead the active international equity and active global/international fixed-income categories.

State Street Global Advisors, Boston, Mass., which ranked seventh in total DC assets with $332.7 billion, continues to rank first in passive international equity and passive global/international fixed income.

Prudential Financial Inc., Newark, N.J., which ranked eighth in total DC assets with $226.4 billion, ranked first in real estate equity and continued to rank first in stable value assets.