DC funds get a much-needed rebound

Providers of mutual funds and target-date funds for defined contribution plans saw their assets under management rise during the year ended June 30, thanks to the market recovery that allowed them to partially make up for the previous year's losses.

For the 12 months ended June 30, the annual survey conducted by Pensions & Investments found that proprietary mutual fund AUM increased 6.7% to $3.58 trillion. The previous year saw AUM plummet by a 19.8%.

Meanwhile, proprietary target-date AUM posted a double-digit increase in the year ended June 30 to $2.64 trillion, an impressive recovery from the 9.7% fall the previous year.

Among target-date funds, those using mutual funds posted an 8.7% gain in AUM to $1.16 trillion.

For collective investment trust-based target-date funds, the AUM increased 15% to $1.26 trillion, the second year in a row that CIT-based target-date funds exceeded mutual fund-based funds.

The separate account category gained 14.7% to $219.8 billion.

The rise in AUM across all categories reflected a market recovery for the year ended June 30 that seemed all the more dramatic given the double-digit negative returns for both public equities and fixed income during the prior year.

For the year ended June 30, the Russell 3000 and Bloomberg U.S. Aggregate Bond index returned 19% and -0.2%, respectively, well above their respective returns of -13.9% and -10.3% for the year ended June 30, 2022.

Sean McCaffery, senior defined contribution research specialist at Fiducient Advisors, said in an interview that clients "continue to see the lion's share of participants go toward target-date funds."

Citing target-date fund lineups as a kind of "one-stop shop," McCaffery said other trends are also continuing, including the broader implementation of passive strategies to save fees as well as provide a safe option from a litigation standpoint.

McCaffery said also that blend or hybrid target-date funds, which offer both active and passive strategies, are starting to gain some traction now.

Some more investment-savvy committees that might also oversee defined benefit plans or endowments are seeking to be active in more inefficient asset classes and passive in efficient asset classes within target-date funds, he said.

"Certainly those are still dwarfed by passive flows," he said.

Meanwhile, participants are reacting to the market's improvement, consultants say.

Bond funds (47%), large-cap U.S. equity funds (23%) and money market funds (21%) were the biggest sources of trading inflows during the second quarter of 2023, according to asset allocations measured by the Alight Solutions 401(k) index.

The index covers changes not including typical contribution flows from more than 2 million participants with over $200 billion in record-keeping accounts with Alight Solutions.

Also in the first half of 2023, the Alight Solutions 401(k) index said that total transfers as a percentage of participants' starting balances was 0.35%. For the six months ended June 30, 2022, that total was 0.86%.

Robert Austin, research director for Alight Solutions, said in an interview that the differences in transfer percentages in 2022 and 2023 were due to the significant changes in market returns.

"When the market goes like what we saw in 2022, people are much more active traders, and that held true to form in 2022," Austin said.

When market returns are positive, he said participants are "pretty much content and really lighter traders."

David O'Meara, senior director of investments at Willis Towers Watson, said that participants have not acted as typically as they have in the past during market upticks.

"Participants ... like most individual investors in the market, will typically react after most recent market movements, and so if recent market movements like stock market movements are down, participants tend to sell afterwards, and when markets turn to start to be more positive, they buy," O'Meara said.

"Defined contribution participants are no different," he said. "We see similar behavior year over year. I know last year, we noticed participants selling out of equities and into bonds in reaction to market declines, and this past year what we've seen is more balance. … There hasn't been a strong bias toward adding risk or removing risk from their portfolios."

While O'Meara said there is not an indication of what is driving their trading activities in any meaningful degree, it's possible the looming recession and commentators seeing it as a "garden variety" recession is keeping participants from veering one way or another.

"They haven't been profit-taking or becoming more defensive," O'Meara said.

One trend seen in the last year has been less of an appetite for going into stable value funds, which according to the Alight index, was the biggest source of trading inflows for the first half of 2022 at 82%.

"We did see rising net flows for participants in stable value for much of 2022, but we did see a pretty sharp reversal of that trend in the fourth quarter of 2022, and then again in the first quarter," said Mark Andersen, senior vice president and manager of the trust advisory group for Callan.

"Those stable value inflows moved to pretty significant outflows to fixed income with a bit of duration, so broad fixed income did see some modest inflows," Andersen said, "and we also did see some inflows into traditional money market funds."

Andersen said that money market funds achieving a 5% yield have made them far more attractive than they have been in the last 10 or 15 years. He added that those target-date fund providers at the margin that can make tactical shifts have increased their money market exposures as well.

Overall, the long-term trend of the majority of participant contributions still going into target-date funds is continuing to gain traction.

"They continue to represent the largest share of new participant dollars, and we think that use of professional management with a long-term strategic solution via target-date funds is a really good solution for a pretty good swath of retirement savers," Andersen said.

Emma O'Brien, senior consultant at NEPC, said in a phone interview that about 63% of participant contributions go into target-date funds, and that has led some of their clients to take another look at their core menu options because they're seeing so many fewer contributions than in the past.

"They have been offering a complementary menu of active and passive options as core options," said O'Brien. "We're taking a look at certain asset classes, whether offering an active option, a passive option or both."

One such asset class is large-cap equities, where offering only a passive option would be the way to go since active managers have struggled to add value, she said.

As of June 30, the average allocation of U.S. DC assets in proprietary mutual funds was 39.5% domestic equities, 31.8% target-date funds, 9.8% non-U.S./global equities, 7.6% domestic fixed income, 5.5% balanced/asset allocation, 4% money market, 1.3% real assets, 0.4% non-U.S./global fixed income and 0.1% other.

Meanwhile, the top five managers of mutual funds in DC plans remain steady in their rankings. Vanguard Group leads the list with $1.09 trillion in U.S. defined contribution plan assets, up 11.1% from a year earlier.

Matthew Brancato, chief client officer for the retirement business at Vanguard, said plans in general have really rallied as an industry to put in place a set of default options (such as target-date funds) and a structure to allow investors to realize the "long-term benefits of being invested in a well-balanced, diversified, low-cost approach that mirrored the revolving risk characteristics" as people age and get closer to retirement.

"We tend to see investors staying the course to a greater extent, and that's terrific," Brancato said.

He also noted that DC plan clients are showing an increased interest in advice options and in "revisiting the retirement readiness part of what the plan lineup can deliver to participants, optionalities around glidepath landing points." He also said plans are having increased conversations on whether money market funds or stable value funds are the right options for their plans.

The remaining top five also saw significant AUM increased. Fidelity Investments was ranked second with $847.6 billion in AUM (up 15.3% from a year earlier); Capital Group, third with $504.5 billion (up 10%); T. Rowe Price Group, fourth with $238.1 billion (2.2%); and BlackRock, fifth with $117.5 billion (10.7%).

Ralph Haberli, president of the institutional retirement client group at Capital Group, said that participants' ability to stay the course with their investments, particularly during the significant market volatility of the past two years, showed that there's a "method behind the madness" of the diversified investment options lineup, with target-date funds and core options.

Haberli also noted that there is growing interest around fixed income, now that the asset class is generating yields in the kind of higher-rate environment the U.S. hasn't seen in 15 years.

Even though Capital Group has managed fixed income for decades, "it's a newer area for Capital in terms of our proactive management in the (DC plan) marketplace, and we have found that in what has been a fairly dynamic market rate environment that there is additional interest in fixed income as an asset class with rates at a higher level."

He noted that mutual funds and collective investment trusts have seen some positive momentum.

A BlackRock spokesperson also said in an email that "given an economic regime of sustained higher volatility accompanied by elevated yields, we're seeing plan sponsors re-evaluate their core bond exposures — and increase their focus on managers that provide diversification and flexibility."

Kevin Collins, head of retirement plan services at T. Rowe Price, said in an email that retirement income is a priority.

"92% of sponsors want to do more when providing retirement income solutions, but only 3% have taken action," Collins said. "As more participants are increasingly keeping assets in their DC plans (89%), there is an opportunity to better assist plan participants with decumulation. We have been focused on innovation with dynamic QDIAs, retirement income tools and calculators, and managed payout funds, like our Retirement Income 2020 Fund that seeks to provide monthly income to investors in retirement."