Sam Kirby, CFA
CAPTRUST Senior Manager | Consulting Research Group
A few years ago, a Las Vegas hotel set a Guinness world record with a marvel of excess: a 510-item buffet line spread across 500 square feet of table space. The event sponsor, an antacid company, not only supported guests with relief stations, but also donated the proceeds—and excess food—to charity.
Thankfully, for participants facing the buffet of defined contribution plan investment choices, there is a trend toward menu simplification. As plan sponsors seek to balance the forces of fiduciary governance, modern portfolio theory, behavioral finance, and industry trends, plans have reduced exposure to specialty asset classes and overlapping options. Even if plan sponsors have dropped fondue stations and potato bars from the buffet, participants have benefitted from more understandable, accessible benefit programs.
Despite this trend, there are two places where plan menus have expanded: target date fund series and passively managed options. This research brief will illustrate these trends and provide context for plan sponsors evaluating such changes within their plans.
Change Beneath the Surface
Every quarter, CAPTRUST aggregates the investment menus of more than 1,000 defined contribution plans to evaluate menu design and participant usage. We examine the number of choices offered and use of capital preservation, asset allocation, and index fund options. Over the past four years, the average and median number of options (counting target date funds as a single option) has remained consistent at 16 choices. Not surprisingly, these numbers can mask activity under the surface; we have observed the addition of some types of options, and the removal of others.
Target Date Trends
There is no shortage of data reflecting the growth of target date funds. Industry research notes the percentage of plans offering target date series, the percentage of plan assets these funds represent, and the percentage of new flows directed to target date fund series are on the rise. As shown in Figure One, CAPTRUST’s data supports these trends, with both plan- and participant-level adoption of target date funds rising in lockstep.
Figure One: Target Date Fund Series Usage
However, as shown by the gold line above, there is one exception to the upward-sloping trend lines we’ve become accustomed to: the percentage of plans using a target date fund series proprietary to their plans’ recordkeeper. This number has decreased among CAPTRUST clients over the past four years.
We do not interpret this data to suggest that target date products offered by asset management firms affiliated with recordkeeping businesses are somehow flawed. On the contrary, CAPTRUST believes these firms offer some of the best resourced and most actuarially sound target date series available. In most cases, they have:
- A rich set of real-world participant data to draw from in designing their glidepaths and underlying assumptions, and
- A long-term commitment to the defined contribution market, supporting the investment required to develop and execute a robust target date strategy.
Rather, the decline in proprietary target date fund usage reflects a positive trend among plan sponsors. They are investing time to understand how participants use these products and their impact on plan economics. This more holistic view, as emphasized by the Department of Labor’s Tips for ERISA Plan Fiduciaries released in 2013, has led plan sponsors to select the target date series that best meets the profile and objectives of their plan from among the range of disparate solutions available, rather than tacitly selecting their recordkeepers' solution.
Passively Managed Options
We have observed an increase in the use of passive options within plans, including the number and type of options offered and participant balances in these options.
Figure Two: Use of Passive Options
As Figure Two shows, the percentage of plan assets in passive options has doubled, growing from 10 percent to more than 20 percent from the fourth quarter of 2011 to the first quarter of 2015. Also, the average number of passive choices available to participants has grown from 2.3 to 3.1. The largest areas of growth have been passive fixed income and international equity options.
CAPTRUST believes three primary factors have fueled this growth:
- Fee awareness. As fees continue to draw regulatory and legal scrutiny, offering participants the ability to invest in low-cost index funds can be an effective way to meet their appetite for choice, while demonstrating a commitment to controlling costs.
- Fee leveling. The migration toward institutional share classes that reduce or eliminate revenue sharing from actively managed funds and recordkeeping technology to distribute administrative costs among plan participants helps address concerns about participant fee fairness.
- Capital markets environment. The market environment of the past five years has made it difficult for active managers to consistently outperform their benchmarks. Because it is difficult, if not impossible, to predict when market conditions will favor active management styles, many plan sponsors have created a wide assortment of passive choices to allow participants to build well-diversified portfolios with low-cost index funds.
If we could peer into the human brain while presenting it with a 500-square-foot buffet table in order to evaluate emotions, the sequence would likely be elation, anticipation, confusion, satiation, and, finally, regret. As plan fiduciaries, we strive to reduce confusion by offering participants a complete, yet rational and balanced, array of choices.
We want to recognize the influence of inertia, and allow participants to self-select the investment solution that best meets their needs. And, we want a durable menu of choices that can stand the test of time through changing capital market conditions, and support the needs of participants as their financial lives become more complex. Sometimes, despite the menu simplification trend, this can lead to offering more choice.
 “Target Date Retirement Funds–Tips for ERISA Plan Fiduciaries,” U.S. Department of Labor, Employment Benefits Security Administration, February 2013.