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401k Heaven Redefined

Nearly 10 years ago, when there were 120 national 401(k) recordkeepers (defined as those that have a national sales force with most attached to a larger financial service organization), it was easy to guess which ones were likely to exit the market next. The hard question was which ones would never exit because of the assets and participants under management built by brand and distribution. I like to refer to these recordkeepers as being in “401k Heaven.”

Today, with fewer than 40 national recordkeepers remaining, the definition of 401k Heaven needs to be expanded to those that are competitive and would surprise most of us if they sold or exited. In my estimation, fewer than 25 of the nearly 40 recordkeepers, or about 60%, can survive the coming “nuclear winter” in the 401(k) market.

The margins on recordkeeping will be either very thin or nonexistent for most providers unless they:

• have massive scale;

• are supported by proprietary investment products; or

• have a post-retirement strategy, like retirement income or IRA rollovers.

The ability to keep proprietary investments in a lineup, whether target date or even stable-value, will only diminish as advisors and sponsors get more sophisticated. Scale is defensible. As in most markets (like the airline industry, for example), the rich get richer — so bigger providers will grow at the expense of weaker ones. With more focus on fee disclosure, prices will only decline and only those recordkeepers that have state of the art technology wrapped by great processes will be able to continually drive down costs by eliminating people from routine tasks.

While a large base of assets and participants driven by brand and distribution are still needed, other factors are coming into play, separating those that will survive and those that will surge ahead. Recordkeepers in 401k Heaven must be able to work in different markets — whether defined by plan size, plan type like 403(b), DB, 457 or Taft-Hartley, — or must be able to capture rollovers or the coming retirement income market. Moving up-market is easier than moving down-market, while crossing over into new plan types has most often been accomplished through acquisitions.

Some of the bank providers and those with significant proprietary distribution networks are uniquely positioned, but only a select few will able to leverage their advantages. If commercial credit and lending stay tight, employers searching for a new provider will look favorably toward their banks that have DC capabilities.
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But banks have a hard time selling across channels. Either the commercial lenders are reluctant to refer a client — fearing potential damage to the relationship if something goes wrong with the retirement plan — or they are not being properly compensated. Banks that own a significant broker dealer, like Bank of America Merrill Lynch or Wells Fargo, have the advantage of legions of savvy sales people who can follow-up on referrals — if they can manage cross-channel selling conflicts and the innate mistrust that naturally arises between two very different divisions of the same company.

There are many other challenges for recordkeepers. It is almost impossible to succeed if senior management teams come and go too frequently. Adding or subtracting a few people is healthy — even the leader — but it takes 18 to 24 months to define a unique and defensible strategy, and about the same amount of time to execute it. Constant change leads to poor morale and high turnover in key client-facing positions like relationship managers and wholesalers.

Additionally, the parent organization — from the very top — must have the will and the nerve to keep investing and pushing the envelope in good and bad markets. Essential to this formula is whether the recordkeeper is making money on its own or shows the promise to be profitable soon. The DC market has proven to be one of the most resilient in bad times, so what used to be a niche market for many has become a core strategy for most. Not all have the will, nerve or capital, and those that surpass the competition will have all three in spades.

Finally, recordkeepers that succeed will focus on translating all their hard work into successful participant outcomes. No longer is it acceptable to rely on good funds, low fees and help mitigating fiduciary liability for advisors and sponsors. While good processes and good people will probably lead to good results, the top recordkeepers will be able to help their advisor and sponsor clients move the needle on retirement readiness.

Only those in 401k Heaven will have the resources to meet that challenge — first by measuring results (defined as increased participant income replacement ratios, or “DC Alpha”) and then by taking a series of steps that can affect these outcomes. Behavioral finance shows that investors, and particularly unsophisticated ones common in DC plans, do not act — and, when they do, they often act irrationally. So plans that incorporate automated features leveraging participant inertia to lead them to rational actions, like higher and escalating deferral rates, as well as more sophisticated and customized asset allocation vehicles, should see the most success. Plans and providers that use experienced and focused DC advisors will show significant improvement over their peers.

It would be too easy to list those recordkeepers in 401k Heaven. Better to see if you can name the almost 40 national recordkeepers and then eliminate those that have lofty aspirations but limited resources.[1] Recordkeepers that can successfully acquire others, which are few and far between, will seize the opportunities that almost seem too obvious to ignore. And while some currently in 401k Heaven will fall from grace, others will be able to take advantage of a fluid and changing market to enter the hallowed ground.

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