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Managed Accounts: A Better QDIA?

While the Department of Labor has outlined three different types of offerings suitable as a qualified default investment alternative, most of the attention — and money — has been directed to target-date funds.

However, a new report by Towers Watson suggests that managed accounts — another of the three QDIA options (balanced funds being the other) — when customized at the participant level, can be a viable, if not superior, alternative.

How Managed Accounts Differ

The report distinguishes managed accounts from TDFs by noting that they are a service, rather than a fund — a service that allows participants to provide personal information and receive individualized asset allocations that are managed on an ongoing basis. Towers Watson notes that, once added to a DC structure, participants typically have access to both an advice tool (advice), where participants remain responsible for implementing an asset allocation, and a professional management service (managed account), where the provider has full discretion and acts as a portfolio manager for participant accounts.

In Towers Watson’s analysis, managed account providers leverage a plan’s core investment lineup to create efficient, diversified portfolios for individuals, and they claim that income planning is supported holistically, with many providers taking into account factors such as retirement goals, minimum income levels, outside assets, Social Security and asset location for tax considerations. Moreover, managed accounts can include asset classes and strategies outside of the core investment lineup that might be too “esoteric” to add to a DC structure as a stand-alone option.

Adoption ‘Rates’

That said, the adopters of managed accounts are plan sponsors, not participants. While more than half (55%) of respondents in Towers Watson’s 2014 DC Plan Sponsor Survey offer managed account services (and 70% offer investment advice), according to Vanguard’s “How America Saves” surveys (admittedly a different survey audience), between 2009 and 2013, reported managed account usage was just 6% to 7% each year, while the percentage of participants offered access to managed account services climbed from 36% to 52%.

Why the gap? The report suggests that in part it may be because participants are simply unaware of the option. But it goes on to say that the major factor driving the lack of adoption is fees. With TDFs, the Towers Watson survey indicates that glide path was the most important consideration (71%), but that fees (54%) were the second-most-important factor.

Towers Watson notes that they often see sliding fee scales for managed accounts starting at around 50 basis points, in addition to fees from the underlying funds (with higher fees for smaller plans). In these managed account constructs, the participants generally also have access to the provider’s advice module, which Towers Watson says is generally free for participants. So, participants are getting the ongoing management but are paying upwards of 50 bps. Towers Watson notes that some participants may consider this a suboptimal trade-off and would require a lower fee to consider using managed accounts for their ongoing portfolio management.

Additionally, the report says that plan sponsors who are considering a managed account as a QDIA — since they often attract a majority of plan assets and the balances of defaulted, unengaged participants — would likely be hesitant to expose those participants to a default option that adds “material fees,” particularly since many new hires default and often have less-complex financial situations in which a lower-cost TDF would sufficiently meet their needs.

The report’s authors acknowledge that the range of additional services offered in addition to asset allocation should have additional costs, but they go on to say that “the managed account industry needs to lower fees before we would expect meaningful adoption of managed accounts as a QDIA.”

Other Options

As alternatives, the report notes that:
• Fee quotes tend to be lower for managed accounts if a sponsor decides to implement them as a default option (typically discounts of 10 bps or more).
• Since younger participants have less complex financial situations, default them into an allocation based solely on age, transitioning them to a managed account as they develop more complex circumstances.
• A greater utilization of strategies outside of the core investment lineup could improve results and the attractiveness of these options.

Additionally, the report notes that the regulatory environment could also change to more explicitly permit such a QDIA structure, similar to the recent Treasury- and DOL-issued guidance that facilitates inclusion of an annuity benefit in a TDF.

The report’s authors also say that they expect managed account providers to become leaders in retirement distribution, but that the success of managed accounts in improving retirement outcomes for participants will depend on their continued evolution in offering professional advice to help participants make complicated decisions regarding Social Security, drawdown strategies and the use of institutionally priced annuities.

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