Virus fuels doubts on DC’s growth curve

With the coronavirus pandemic delivering a near knockout blow to the markets in the first quarter, money managers are not venturing any guesses as to whether assets in defined contribution plans will keep pace with the momentum they saw last year.

In terms of DC asset growth, 2019 was a formidable year, with U.S. institutional tax-exempt assets climbing 18.1% to $7.9 trillion from $6.69 trillion in 2018, according to Pensions & Investments' annual survey of U.S. institutional money managers.

A turbocharged bull market that lifted values across virtually all asset classes was the main driver behind the jump in DC assets last year, industry experts said. U.S. equities, as measured by the Russell 3000, and non-U.S. equities, as measured by the MSCI ACWI, climbed 31% and 21.5%, respectively.

The Bloomberg Barclays U.S. Aggregate Bond index also rose 8.7%.

Broad asset classes in the survey showed that the top 100 DC managers had 67.1% of assets invested in equities, up 2.5 percentage points from 2018. Fixed income edged down less than a percentage point to 18.7%.

"There really wasn't an area where you could have gone wrong in 2019," said Jason Shapiro, director of investments at Willis Towers Watson PLC in New York.

What seemed like an endless market upswing, of course, abruptly ended with the outbreak of COVID-19 in the U.S. in the first quarter.

See more of P&I's special report on DC Money Managers

The S&P 500 plunged 20% as of March 31 only to recover most of the losses by the end of June when the index was off a more manageable 4.04% from the start of the year. The roller-coaster ride essentially brought plan participants back to where they started, Mr. Shapiro said."I estimate that they're probably about flat from a return perspective and maybe even up a little bit when you think about their contributions," Mr. Shapiro said, referring to participants in multiasset portfolios who invested for the long term.

The whiplash, however, left an indelible mark on participants and plan sponsors, with sponsors beginning to have conversations about the role of the various asset classes within a plan's default investment option, according to industry experts.

If the goal of a specific asset class is downside protection and a plan's default option did not provide the expected protection during the market downturn, plan sponsors are likely to look for replacements, Mr. Shapiro said.

Michael Volo, senior partner at Cammack Retirement Group in Wellesley, Mass., for example, anticipates that plan sponsors are going to have a greater focus on the risk profile of their target-date suite and performance. Plan sponsors will be looking into whether their target-date suite "cushioned the blow in the volatile equity markets as it should have," he said.

The broad asset categories from P&I's survey incorporate underlying assets from target-date and balanced funds, mutual funds, separate accounts and commingled funds such as collective investment trusts.

See more of P&I’s coverage of the coronavirus

Industry experts agreed that as plan sponsors review their investment options, they will continue to be focused on low-cost funds, as they were last year. In 2019, target-date funds, a relatively low-cost investment option, posted notable asset gains, rising 30.7% to $1.89 trillion from 2018 and more than double the $811.2 billion in 2014, according to P&I's annual survey.

Vanguard Group Inc., which again topped all managers with $1.52 trillion in U.S. institutional tax-exempt DC assets, up 29.1% from 2018, attributed the growth in part to its target-date funds. "Due to their diversification benefits and wide use as QDIAs in defined contribution plans, Vanguard's target-date series continue to lead the industry in cash flow," said James Martielli, head of investment solutions within Vanguard's institutional investor group in Malvern, Pa.

Vanguard's target-date funds posted nearly $69 billion in inflows in 2019, and through year-to-date June 30 had amassed $16 billion in net inflows, according to Mr. Martielli. Overall, Vanguard's target-date strategies held $650.1 billion in assets as of Dec. 31, up 36.7% from $475.6 billion the year before, according to P&I data.

BlackRock Inc., ranked second with $1.04 trillion in DC assets, also attributed the 25.6% jump it posted in DC assets in part to its LifePath target-date franchise. Assets in the target-date series were up 36% from 2018, said Anne Ackerley, managing director and head of BlackRock's retirement group in New York.

BlackRock's target-date strategies held a total of $255.1 billion as of Dec. 31, according to P&I data.

"In terms of organic growth, we anticipate BlackRock will continue to outpace the industry, particularly in our target-date franchise given the breadth and strength of our franchise, our dedication to innovation and deep client relationships," Ms. Ackerley said.

Capital Group Cos. Inc., sixth among managers with $451.4 billion in assets, up 23.2% from 2018, partly chalked up its growth to its "superior, risk-adjusted returns" as well its target-date strategy, a "consistent driver of growth in assets and market share," said Ralph Haberli, president of Capital Group's institutional retirement client group in Los Angeles.

Assets in Capital Group's target-date strategies totaled $138.2 billion as of Dec. 31, and grew 48% year-over-year driven by strong gross sales, net flows and market appreciation, he said.

Capital Group also attributed its growth to the rollout last year of collective investment trusts, which gave the firm access to a wider segment of plan sponsors, Mr. Haberli said, adding that target-date CITs raised $2.3 billion in assets in 2019.

"Capital heads into the second half of 2020 and beyond with strong momentum and a path to continue to expand our reach across DC plans and plan participants," he said.

The ongoing focus by plan sponsors on investment costs is reflected in the robust growth of commingled funds, which outpaced that of mutual funds, according to P&I's survey findings. Commingled funds totaled $2.37 trillion in assets, up 19.5% from $1.99 trillion in 2018. Mutual funds, in contrast, grew 15.4% to $2.9 trillion.

On a five-year basis, the growth rate of commingled funds relative to mutual funds is even more stark. Commingled funds AUM jumped 61.3% since 2014 while mutual funds grew 29.4%.

The faster growth of commingled funds is driven by the desire for lower fees and plan sponsors becoming more comfortable utilizing the options, such as collective investment trusts, and communicating them to participants, Cammack's Mr. Volo said.

Mr. Volo expects commingled funds to continue to grow faster than mutual funds in the near term as information about the pooled vehicles become more readily available, but he sees low-cost mutual fund share classes "closing the gap."

Ross Bremen, a partner at investment consultant NEPC LLC in Boston, also sees commingled funds continuing to grow faster. "All the fee litigation has certainly led plan sponsors to consider lower-cost collective trust offerings," he said.

Of note, separate accounts posted even healthier growth than commingled funds on a year-over-year basis. In 2019, separate accounts reached $1.46 trillion in assets, up 20.8% from $1.21 trillion in 2018 and up 54.9% from 2014.

The desire for lower-cost investments also helps explain the continuing popularity of passive investments over active.

In 2019, assets in passive domestic equity jumped 31.6% to $1.95 trillion compared with active domestic equity, which increased 18.2% to $1.79 trillion. On a five-year basis, the growth is more pronounced, with passive domestic equity climbing 89.7% vs. active domestic equity, which rose just 29.3%.

The trend also holds in fixed income. Passive domestic bonds, for instance, reached $481 billion in assets last year, up 26.4% from 2018 and double the $239.8 billion in 2014. Active domestic bonds, which last year accounted for $1.12 trillion, in contrast, grew just 4.8% on a one-year basis and 16.8% on a five-year basis.

While industry observers generally see passive investments continuing to win favor as plan sponsors look to minimize litigation risk, some see potential for the trend to reverse itself given the dislocations that exist in the marketplace.

"I would say active managers were a lot more excited maybe a few months ago than they are now, but I think that they still have a lot of expectation that dislocations (will create) opportunities for active management," said Ben Taylor, senior vice president and head of tax-exempt defined contribution research at Callan LLC.

However, he added, "If you have significant risk of a down market, you also have increased risk of stock-drop losses (in a company stock investment option) and a lot of what's been driving passive investments is not only the theory that passive investments might be a better net-of-fee performance option but also a bit of protection for plan fiduciaries who are concerned about stock-drop lawsuits and fee suits," Mr. Taylor said.

While Mr. Taylor did not know which of the two forces "will net out to be stronger," he sees that the trend to passive can continue as an "easy-to-defend model."

How this will all play out in the second half of the year in terms of total DC assets is anyone's guess, observers said.

"I think that if 2020 has taught anyone anything, it is that hubristic projections of the future are not the best enterprise to engage in," Mr. Taylor said.