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Pensions & Investments: A 'Difficult Period' Pushes DC Assets into the Basement

July 23, 2019

Ross Bremen was featured in a piece on how DC asset managers are managing their investments in a difficult market. View the article on P&I's site here. 

Thanks to a brutal fourth quarter, defined contribution asset managers were hard pressed to find positive news by the end of last year.

Most broad asset categories saw a drop in assets under management: passive and active domestic equity; active and passive international equity; passive global equity; and active global/international fixed income, according to an analysis of Pensions & Investments' 2018 survey of DC money managers.

Internally managed U.S. institutional tax-exempt assets fell 5.2% to $5.84 trillion in 2018; total assets sank by 5.4% to $6.69 trillion as of Dec. 31.

"The market in general had a difficult period," said Greg Ungerman, senior vice president and defined contribution practice leader for consultant Callan LLC, San Francisco.

Like other DC consultants and asset managers interviewed, Mr. Ungerman attributed much of the declines in the various equity asset categories to market activity rather than to participants making pronounced investing changes.

"DC participants are not driving one asset class vs. another," said Ross Bremen, a partner at investment consultant NEPC LLC, Boston. "DC participants tend to move after markets have already moved."

However, if DC participants exercised patience, their account balances likely would have rebounded. For the first half of 2019, the S&P 500 stock index climbed 18.54%; the Russell 2000 gained 16.98%; the MSCI All Country World index ex-U.S. advanced 13.6%; and the Bloomberg Barclays U.S. Aggregate Bond index rose 6.11%.

The P&I analysis reveals several broad trends last year:

Passively managed equity assets fell less than their active counterparts in both domestic and international categories.
Domestic equity assets fared better than international equities as assets declined less.

Passively managed domestic fixed-income assets rose at a higher rate than actively managed domestic fixed income assets.

Target-date fund assets rose 2.8% to $1.48 trillion in 2018 and were up 133.5% over five years. Custom target-date fund assets slipped 0.8% to $137.3 billion, but they are up 155.8% over five years.

The broad asset categories from P&I's survey incorporate underlying assets from target-date and balanced funds, mutual funds, separate accounts and commingled funds such as collective investment trusts.

Although active domestic equity and passive domestic equity assets both fell in 2018, the latter has enjoyed such significant growth in recent years that it is poised to overtake the former.

For the 12 months ended Dec. 31, actively managed domestic equity assets dropped 9.5% to $1.52 trillion while passively managed domestic equity assets declined 6% to $1.49 trillion, according to the P&I survey. For the five years ended Dec. 31, passive domestic equity assets climbed a cumulative 65.6% vs. active domestic equity's gain of 4.6%.

A continuing bull market and greater fee fealty by plan sponsors are some of the reasons for the surge in passive investing, consultants said.

ERISA lawsuits challenging fees have prompted sponsors to offer more index funds, said Bradford L. Long, partner and research director of global public markets for investment consulting firm DiMeo Schneider & Associates LLC, Chicago. And if active managers, especially in areas such as large-cap domestic equity, cannot outperform respective indexes, sponsors will offer — and participants will choose — less expensive index funds, he added.

"For every one of my clients, they are looking to add more passive equity funds," said Martin Schmidt, principal at MAS Advisors, a defined contribution consulting firm in Chicago. "They are not looking to add more active equity funds."

Passively managed equity has done well because "it offers value for money and convenience," said Nick Nefouse, managing director, co-head of the LifePath target-date business and head of the defined contribution investment and product strategy at BlackRock Inc., New York. "You know what it is, and you can do it very cheaply."

Mr. Nefouse acknowledged the impact of ERISA lawsuits on some sponsors' actions. "Litigation is a driver, but that doesn't mean everybody looks for the lowest cost possible," he said.

BlackRock is the second-largest manager of passive domestic equity for DC plans. Its passive domestic equity assets declined 6.5% to $406.8 billion last year vs. $435 billion in 2017, in line with the overall trends identified by P&I. "Asset flows tend to follow markets," said Mr. Nefouse said.

The largest passive domestic equity manager — Vanguard Group Inc., Malvern, Pa. — ran counter to the national trend, as assets rose 2.6% to $737.2 billion last year vs. $718.8 billion in 2017.

Vanguard has benefited from sponsors' greater use of target-date funds, especially as qualified default investment alternatives, said James Martielli, the firm's head of defined contribution advisory services. Index-based target-date funds are "getting the lion's share of flows" vs. actively managed target- date funds among Vanguard clients, he said. Although sponsors are adding index-based investments, they aren't coming as replacements to active investments, he added.

Vanguard's recent annual analysis of client activity shows 63% of DC plans offered an "index core" last year, continuing a steady annual increase compared to 38% in 2009. During this period, the percentage of clients offering an index core and target-date funds rose to 59% from 29%.

Vanguard defines an index core as "broadly diversified index funds" for U.S. stocks, U.S. bonds and international stocks. "The definition includes index funds for large-cap U.S. stocks, intermediate or long-term bonds, and developed markets," according to Vanguard's report.

Vanguard remained the top provider of total internally managed DC assets with $1.04 trillion as of Dec. 31, a 4.2% gain for the year. BlackRock remained in second place with $829.8 billion, down 3% from the end of 2017.

International equity pinched
International equity assets fell further than their domestic counterparts last year.

Actively managed international equity dropped 21.2% to $371 billion last year, while active domestic equity lost 9.5% to $1.52 trillion.

"International markets have clearly lagged," said Steve Caruthers, a Los Angeles-based equity investment specialist at Capital Group Cos. Weaker economies, tariff-caused trade tensions and turmoil over Brexit are the primary reasons why aggregate assets in international equity markets have been depressed, he said.

However, amid the overall declines of actively managed international equities in the P&I database, Capital Group emerged virtually unscathed. The leader in actively managed international equities reported assets of $142.1 billion last year vs. $144.6 billion in 2017.

"Healthy net flows to the American Funds target-date series in 2018 contributed to Capital Group's strong showing," Mr. Caruthers said. "In addition, EuroPacific Growth Fund and New Perspective Fund had positive net flows exceeding $1 billion in 2018. The American Funds target-date series exceeded $10 billion in net new flows in 2018."

Capital's active domestic equity assets also fared well vs. competitors as last year's $156.7 billion in assets was essentially flat compared to $159.6 billion in 2017.

It was a different story for Fidelity, whose actively managed international equity assets fell 30.2% to $62.4 billion in 2018 vs. $89.3 billion in 2017, placing second in the P&I database. During the same period, its active domestic equity assets — also the second largest in the P&I database — dropped 8.4% to $290.2 billion from $316.7 billion.

The largest manager of passive international equities, State Street Global Advisors, Boston, saw assets fall 23.7% to $77.1 billion last year.

"The markets have been punishing international equities," said David Ireland, senior managing director and global head of defined contribution. SSGA's passive international equity assets also were affected last year by the loss of a large client due to a "pricing related" issue, said Mr. Ireland, who declined to identify the former client.

Mr. Ireland said the overall forecast for passive equity is favorable given sponsors' desire to reduce costs, expand lineups, reduce fiduciary risk and increase the use of target-date funds. SSGA remained the third-largest manager of passive domestic equity assets last year with $157.9 billion, down 7.1% from the end of 2017.

Although sponsors and consultants preach diversification, international equity remains dwarfed by domestic equity in DC plans, a residue of home-country bias, DC consultants said.

International equity remains the "poor stepchild" of DC plan asset allocations, said Mr. Schmidt of MAS Advisors. "Plan sponsors are not looking to expand the types of international offerings."

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