Defined contribution investment only firms will fare well in keeping fee compression, customized target-date funds and specialized advisory relationships on top of their to-do list in 2013.
According to figures from the Investment Company Institute, Americans held $5.1 trillion in all employer-based defined contribution retirement plans on December 31, with $3.6 trillion held in 401(k) plans. Mutual funds managed $2.9 trillion of assets held in 401(k), 403(b), and other DC plans at the end of December, up from $2.8 trillion at the end of September. Mutual funds managed 57% of DC plan assets at the end of the fourth quarter.
Bridget Bearden, senior research analyst at research firm Strategic Insight, expects DC assets to grow to over $6 trillion by 2017, and of which she expects mutual funds to manage some 60%.
One sure way of drawing advisors and sponsors in a tight battle field is to lower fees. And many providers of investment-only plans are turning to "zero-fee-share" share classes to do so.
These "zero fee-share" classes-which are most commonly packaged as R6 shares-cull embedded investment costs such as revenue sharing, 12b-1 and sub-transfer agent fees inherent in mutual funds and fund trusts, and charge only the investment management fee.
The idea is to not only lower costs, but to also offer sponsors and participants greater transparency and simplicity in gauging the fee structures of funds. The practice of offering zero-fee share classes gained traction in 2012, with firms such as Wells Fargo, Thornburg and Putnam Investments all announcing new R6 shares, and continued this year with Neuberger Berman's plan to launch a R6 share class in mid-March.
"It's a definitive trend in the marketplace," said Sean Murray, senior vice president and national retirement sales manager, defined contribution practice, for PIMCO. "If you have R6, great, you can play. If you don't, you're not going to have ability to be engaged in those searches [for product] that are happening."
Fee compression isn't the only trend having a ripple effect. Open architecture, whereby 401(k) plan providers use mutual funds from other providers as well as their own, is proving to have wide market appeal and demand. But recordkeepers wishing to stay competitive "have to be open architecture even in the mid- and small-plan sizes," Matt Sommer, Janus Capital Group director and senior retirement specialist, said.
This is evident with target-date funds, which continue to be popular among DC plans. "A lot of managers now have target date funds, where if you don't have one, you have an issue," noted Fred Barstein, founder and executive director of The Retirement Advisor University and editor-in-chief of the National Association of Plan Advisors' website.
Once in the game, target-date fund providers are under pressure to offer custom offerings. Indeed, more and more sponsors are demanding the freedom to choose the glide paths, or how a fund's allocation mix of equity, bonds, and cash is managed, to find underlying investments that are right for them. They clearly have sway: In May 2012, Vanguard rocked the presses by announcing that it would open up its recordkeeping platform to allow outside target-date funds.
Bearden estimated that the total global target-date market amounts to around $750 billion, of which some $500 billion is placed in U.S. mutual fund structures.
"DCIO (firms) are trying to help advisors understand why they should be in custom target date funds," Murray said. At the same time, "Until you get to a plan size of $500 million-or more ideally, $1 billion-it can be very difficult to implement 'truly custom' target dates because of operational hurdles, time and cost," he added.
Among the top 50 largest defined contribution plans, two-thirds have already gone the custom route, noted Fredrik Axsater, global head of defined contribution at State Street Global Advisors, which focuses on large and mega plans with $1 billion in assets or more. "Larger plans no longer make bundled decisions. They are moving toward customized solutions. So the opportunities are greater for active managers with mega plans and also niche providers," he said. Examples of such plans include the State of Colorado and other state plans, which tend to be more risk-averse and value capital preservation, Axsater said.
Open architecture can also apply to asset allocation series, Bearden said, where sponsors can pick and choose underlying investments to fit a pre-established glide path within qualified default investment alternatives like target date and target risk funds, she said. "This presents more opportunity for DCIO (fund) managers, especially ones that might not be able to get placement right on the 401(k) plan itself as an individual investment option," she added.
In line with the desire for lower fees and customized products in the DCIO space is the growing presence of specialist wholesalers. "What advisors are looking for is a business partnership and someone who can truly add value," Murray said. "Most advisors in the upper end are not buying off-the-shelf value-add resources. So our wholesalers are very well-versed and trained to help within their business models."
In trying to move upmarket, "matching task to talent is key," Sommer said. DCIO plan wholesalers facing off with advisors and consultants like Mercer and Aon Hewitt who specialize in 401(k) plans, must be able to "articulate their value propositions" and "show clients how they're being compensated."
"A lot of people are hiring more wholesalers, and the ones that are doing really well are being more strategic," Barstein said. "They're being relied on heavily for the value-add to help advisors build, grow and manage their businesses. And that's become a little bit of an arms race."
And what qualifies as good value-add? "Value-add should be unique, actionable and compatible with the [advisor's] brand, and it should help build that relationship," Barstein said.