Defined contribution investment-only (DCIO) sales leaders and DC plan advisors report that they are seeing increased demand for collective investment trusts (CITs), even among smaller firms where CITs are less in fashion.
According to Sway Research’s 2024 edition of The State of DCIO Distribution, the average DCIO unit is generating 20% of gross sales from collective trusts this year, up from just 8% in 2018, while 69% of sales are coming via mutual funds in 2023 versus 83% five years ago.
Meanwhile, DCIOs estimate that 22% of current CIT-based DCIO sales, on average, is being generated in DC plans with less than $50 million of AUM, and another 23% from plans with between $50 million and $100 million.
When asked about demand for collective trusts across market segments, none of the 20 responding DCIOs believes demand for CITs is decreasing in any segment of the market, the report notes. Moreover, all agreed that demand is up in the $50 million to $100 million plan space, and all but a single DCIO selling CITs in under $50 million plans indicated they are experiencing rising demand in that segment, too.
Sway notes that these findings come as, for the fifth consecutive year, a top goal of DCIOs is to lower expenses on key products, as 78% of asset managers surveyed say this is a top five priority heading into 2024. While some active managers achieve this by increasing passive management capabilities, such as by converting a previously active target-date series to a hybrid approach, the most common strategy is to launch new CIT versions of existing portfolios with lower fees.
Litigation Fears, Managed Accounts and the QDIA Space
Another key finding from the report suggests that a fear of litigation is keeping advisor-managed accounts out of the qualified default investment alternative (QDIA) sphere.
As one might presume, cost remains a significant issue for advisor-managed accounts. According to Sway’s findings, nearly a third (30%) of plan advisors surveyed believe the risk of litigation is significant or high for a plan that uses an advisor-managed account as a QDIA when a cheaper target-date series is available.
Additionally, more than half (55%) of plan advisors surveyed agreed that managed accounts are “too expensive” relative to target date funds (TDFs).
Consequently, TDFs continue to dominate the QDIA selections of plan advisors. Nearly three-quarters of the QDIA assets managed by DC plan advisors is invested in TD series, with two-thirds of this going to products run by a DCIO manager (i.e., a firm not affiliated with the plan’s recordkeeper).
Meanwhile, managed accounts are gaining DC asset share, but the pace of these gains is miniscule relative to the size of the overall DC market, the report further notes. For instance, Sway estimates that assets invested in Edelman Financial Engines and Morningstar Retirement Manager—two of the largest providers of advisor managed accounts—totaled less than 4% of total DC market assets at the end of 2022.
Sway also estimates that TD series currently control a third of DC assets, largely due to their frequent use as default investments for auto-enrolled participants.
Relationship Pricing
Additional findings show that DCIOs are increasingly utilizing relationship pricing, which is driving flows into CITs. According to Sway, the average manager has established relationship pricing arrangements, in which fees are customized (i.e., discounted via special CITs), with six recordkeepers and/or distributors. On average, these firms are capturing about 10% of gross DCIO sales through such initiatives.
The level of discount typically depends on the level of assets expected to be captured via these arrangements, as well as the asset class. Sway notes, for example, that there generally is more room to lower expenses with an equity portfolio than a bond fund. However, assets promised are not always raised. Less than 60% of relationship pricing arrangements have met expectations to date for the average DCIO. While some firms have had only good experiences, others said only a quarter or less of arrangements were successful.
These firms indicated it was often the failure of their product to perform as expected that caused the shortfall. The second most common reason cited for failure is that the DCIO firm was not a top-tier partner, in terms of supplying sales and marketing support, to the partner firm, the report notes.
Concern About ESG Investments
Plan advisors also express concern over potential litigation from the use of ESG-based portfolios in plan investment menus, despite regulatory changes in late 2022 that were supposed to alleviate this issue. In this case, 42% of plan advisors surveyed believe that selecting an ESG fund that then underperforms its benchmark carries significant or high litigation risk.
Moreover, roughly half agree that a new wave of litigation stemming from ESG suitability is likely coming in the months ahead. Value-add marketing that addresses this issue—as well as aiding advisors to clearly articulate and document the investment selection process—will be crucial to ESG achieving success in DC, the report emphasizes.
DCIO Asset Bases and Sales
Overall, Sway reports that DCIO asset bases largely improved in what has been a solid year for stocks so far, but most remain well shy of year-end 2021 levels. Sway projects DCIO AUM will reach $5.9 trillion by the end of 2023—making back more than half of the assets lost in a difficult 2022, but still down about 8% from the end of 2021.
The average manager experienced a 12% rise in DCIO AUM in the first half of 2023 on the strength of solid gross sales, which averaged 58% of full-year 2022 levels.
Now in its 17th year, this year’s report is based on surveys and interviews conducted in the summer of 2023 among DCIO sales leaders from 20 leading asset management firms with nearly $3 trillion of DCIO AUM, retirement plan-focused intermediaries from 207 advisory practices with more than $144 billion of DC AUM, and 30 DCIO field wholesalers from 20 asset management firms.
