Market returns make up for lower participant flows

Assets in defined contribution retirement plans climbed to a new year-end high last year, thanks almost entirely to stock market gains.

At the end of 2020, U.S. institutional tax-exempt assets rose 11.9% to $8.88 trillion from $7.94 trillion in 2019, according to Pensions & Investments' annual survey of U.S. institutional money managers.

Internally managed defined contribution assets rose even more, jumping 14.7% to $7.95 trillion.

The robust growth might have been stronger were it not for the pandemic, which stymied new asset flows throughout the year. The outbreak of COVID-19, along with last year's market volatility, caused plan participants to either pull money out of their retirement plans or stay the course and not contribute more, industry observers said.

"The biggest driver for the increase was asset appreciation as actual net flows — due to the impact of the COVID-19 — were modest," said Jim Danaher, a principal and investment consultant in the wealth practice at Buck Global LLC in St. Louis.

David Blanchett, Lexington, Ky.-based managing director and head of retirement research in the DC solutions group at QMA LLC, PGIM Inc.'s quantitative equity and multiasset specialist, also didn't see much in the way of net new flows, explaining that money in and out of retirement plans have been "pretty much" equal for the last five to 10 years. "I didn't see a large net change," he said of last year's asset flows. "It would have been more positive had we not had the COVID crisis."

Some observers noted increased hardship withdrawals from plans at the onset of the pandemic. "Many plans observed heavy distribution activity in the first and second quarter of 2020 due to the liberalization of withdrawal policies under the CARES Act," Mr. Danaher said.

The 11.9% upswing in total defined contribution assets noted in P&I's survey was in line with broad market returns. U.S. equities, as measured by the Russell 3000, and non-U.S. equities, as measured by the MSCI ACWI ex-US, climbed 21% and 11% in 2020, respectively. Meanwhile, fixed income, as measured by the Bloomberg Barclays U.S. Aggregate Bond index, rose 7.5%. Non-U.S. bonds, as measured by the FTSE WGBI ex-U.S., jumped 10.8%.

Equity accounted for the greatest share of assets in defined contribution plans. The top 100 DC managers had 67.1% of assets in equities managed internally, essentially unchanged from 2019. Fixed income, the next largest asset category, edged down almost 2 percentage points to 16.8%, while stable value rose 2.3 percentage points to 8.2%.

The three largest DC money managers in terms of U.S. institutional tax-exempt assets — Vanguard Group Inc., BlackRock Inc. and Fidelity Investments — defended their positions in the top three spots, with Fidelity breaking $1 trillion in assets, a milestone that thrust it into the company of its two rivals. The $1 trillion-plus trio, which each posted double-digit asset growth rates, attributed the gains at least in part to the continuing popularity of target-date funds.

Matthew Brancato, principal and head of Vanguard Institutional Investor Services in Paoli, Pa., noted the strength of Vanguard's target-date business, which leads the industry. At the end of 2020, the money manager's target-date strategies managed internally held $730 billion in U.S. institutional tax-exempt assets, more than twice its next nearest rival BlackRock, according to P&I data.

Vanguard's target-date funds use "a simple, yet sophisticated, low-cost portfolio solution," Mr. Brancato said.

Overall, Vanguard remained at the top of the leaderboard with $1.74 trillion in U.S. institutional tax-exempt DC assets, up 14.3% from 2019.

BlackRock, ranked second with $1.21 trillion in assets, also attributed the 15.7% jump it posted in DC assets in part to its "strong target-date franchise," said Anne Ackerley, the New York-based head of BlackRock's retirement group. BlackRock's target-date fund assets grew 21.5% over the year to $309.9 billion, taking over the No. 2 spot from T. Rowe Price Group.

Ms. Ackerley noted that BlackRock's target-date platform is used by DC plans of all sizes, including about 25% of the Fortune 100. "BlackRock pioneered the industry's first target-date fund in 1993 and has a unique track record of enhancing LifePath strategies to meet evolving participant needs," she said.

Fidelity posted the most growth of the three, jumping to $1.04 trillion, up 20.9% from the year before. The money manager attributed the increase to "positive market performance of 2020" as well as its open architecture approach, technology and its target-date business, Michael Shamrell, a Boston-based Fidelity spokesman, said in a statement.

At the end of 2020, Fidelity's target-date strategies held $233.6 billion in assets, up 14.7% from the previous year, according to P&I data.

"We've seen continued growth in our Freedom Fund business as an increasing number of participants invest their retirement savings in target-date funds," he said.

Mr. Shamrell noted that as of March 31, more than half of all Fidelity participants (56%) held all of their 401(k) savings in a target-date fund, up from 43% five years ago.

Unquestionably, target-date funds continue to dominate DC asset flows. Target-date funds had $2.21 trillion in assets to end 2020, up 16.9% from 2019 and more than double the $901.4 billion total in 2015, according to P&I data.

"Target-date funds are without a doubt the most popular default investment in defined contribution plans," QMA's Mr. Blanchett said. "I do think they will continue to achieve a growing share of DC assets."

Buck's Mr. Danaher was particularly impressed with the growth of custom target-date funds, which had $165.8 billion in assets at the end of 2020, up nearly 25% from 2019 and up 74.9% from 2015, P&I data show.

"While much of this growth is being driven by jumbo and mega plan sponsors, it's not hard to see the eventual democratization of that trend as target-date funds increasingly dominate DC plan balances driven by their role as the primary qualified default investment alternative," Mr. Danaher said.

Commingled vehicles and separate accounts also posted robust growth, outpacing mutual funds, as plan sponsors looked to reduce fees, observers said.

Commingled vehicles had $2.76 trillion in assets in 2020, up 15.9% from 2019, while separate accounts totaled $1.70 trillion, a 16.3% year-over-year increase, according to P&I data. Mutual funds, in contrast, grew at a more moderate 12.9% to $3.28 trillion.

"It's all about lowering fund expenses," Mr. Danaher said, referring to growing use of commingled funds and separate accounts. "DC plan sponsors are drawn to the more attractive pricing available under both collective investment trust and separate account structures for distinct asset classes."

Michael Volo, a Boston-based principal at CAPTRUST Financial Advisors LLC, echoed similar views. "The growth in commingled funds is driven by plan sponsors being fee conscious and wanting to mitigate their fiduciary risk," he said.

The focus on fees also helps explain the continuing preference of passive investments over active. In 2020, assets in passive domestic equity totaled $2.25 trillion, compared with active domestic equity at $2.08 trillion, according to P&I data.

While active domestic equity grew marginally faster than passive domestic equity last year, it still trails passive on a five-year basis. Assets in passive domestic equity more than doubled since 2015, growing 110.8%, while active grew 54.5%. On a one-year basis, growth rates were similar, with passive growing 15% and active growing 15.9%.

"I think that a lot of plan sponsors are focused on cost and one way to reduce the overall expenses is to go with a passive or indexed equity strategy," Mr. Blanchett said.

Also notable was the dramatic growth of passive domestic fixed income, which climbed 20.2% year-over-year to $577.9 billion. Active domestic bonds, in contrast, rose 12.4% to $1.26 trillion.

"I think the trend of investors choosing passive fixed income over actively managed funds follows the trend we've seen in equity funds over the past decade," Mr. Volo said. "Another contributing factor is that many of the largest, most widely-held actively managed fixed-income funds underperformed in 2020's choppy waters."

While the market volatility may have hurt active bond funds, it helped stable value funds, which posted strong asset gains. In 2020, assets in stable value swelled 14.7% to $417.2 billion, according to P&I data.

"I think part of the growth in stable value can be attributed to participants moving into the asset class given the volatility in 2020 and all the uncertainty in the market," QMA's Mr. Blanchett said, explaining that stable value funds can be "a very attractive place to park money for the short-term."

"It's an incredibly attractive option for someone who is worried about a market drop or any kind of other future economic uncertainty," he said.

Money managers also posted healthy growth in assets managed under ESG principles, which surged to $2.04 trillion, up 30.3% from 2019, according to survey data.

"ESG is obviously an area of increased interest not just in DC but across all investors," Mr. Blanchard said, noting that concerns about ESG strategies in 401(k) plans have abated somewhat with the new administration. "I think it's a definite growth area and would expect assets managed under ESG principles to continue to increase in the future."

As money managers head into the final five months of 2021, industry observers are cautiously optimistic that market performance will enable the growth of DC assets to surpass last year's rate.

"DC assets will continue their ascent, supported by the rebound in the U.S. economy, the reopening of America and employers shifting their focus to programs designed to re-engage their workforce," Buck's Mr. Danaher said.

The market, too, can help. If the market cooperates and continues its upward trajectory, DC assets will grow along with it. "As the equity and fixed-income markets go, so goes the growth of defined contribution plan assets," Mr. Volo said.

Mr. Blanchett sees other trends that could begin to boost DC assets beyond what the market returns for the year. The growing use of automatic increases in employee contributions and efforts to retain retiree assets in-plan, he says, are trends that could help the overall asset growth.

"I think that there are things happening that could result in assets in DC plans growing more than just the market lift," he said.