It's been nearly three years since Enron Corp., and its 401(k), imploded, raising concerns about the safety of corporate defined contribution plans. Still, many workers remain remarkably apathetic about their retirement savings plans, declining to fill out the requisite forms to identify where their plan contributions should be invested.
As a result, employers have been looking more seriously at so-called automated investment selections, in which the plan provider or plan sponsor makes choices traditionally made by the employee. In designing their plans, some sponsors include a default option in which the employer determines where contributions will be invested if a plan participant does not decide. Among a plan's investment options, another category of automated selection is life-cycle funds, which are funds of funds created from a provider's product line and designed to offer age-appropriate asset allocation. Finally, in recent months the industry has been pushing the latest variation, managed accounts, in which independent investment advisers help create portfolios based on questionnaires filled out by participants.
According to the 1974 statute that governs retirement plans, 401(k)s that automatically enroll participants must include investment defaults, and profit-sharing defined contribution plans must provide a way for employees to automatically receive a contribution from their employer. Lately some plans that neither automatically enroll their employees nor automatically contribute to their employees' accounts also have been including default options in an effort to address investor passivity.
A recent survey conducted by the Profit Sharing/401(k) Council of America, a trade organization, found that 4 percent of 1,046 plans with a total of $244 billion in assets had default options. Among the largest plans in the PSCA survey, about one fifth (21.1 percent) are automatically enrolling their participants and therefore have default options.
From the perspective of a plan provider, the default choice is critical, since the money usually doesn't move. Traditionally, companies have chosen low-risk money market funds or stable value funds as their default options, judging them the safest way to meet their fiduciary obligations. In the past few years, more and more plan sponsors have been turning to life-cycle funds, in which every five years or so the asset mix grows more conservative as the participant ages.
Now money managers are aggressively pushing managed accounts for the default option or as another investment alternative. These portfolios are more personalized than life-cycle funds, in that each participant defines his risk tolerance and investment goals. Typically, asset allocation is rebalanced quarterly to make sure the portfolio conforms to the participant's goals, and the adviser sends the participant an update. Once a year, usually, a representative of the advice provider will phone a plan participant to review performance and risk issues.
Says Don Salama, a managing director of New York Life, which is introducing its managed account this month, "We believe this is the single-greatest enhancement to the 401(k) plan since the automation of recordkeeping."
As plan sponsors worry about employees suing them for overly conservative investment choices in the default option, managed accounts offer an approach more tailored to the individual.
Selling a managed account requires an alliance between a plan provider -- usually a mutual fund company or an insurance company -- and an independent third-party financial adviser. This new product was made possible by a December 2001 Department of Labor ruling that sanctioned advice from third-party sources as long as they remain independent of the investment manager handling the 401(k) portfolios.
The four largest independent advisory firms: online advice providers Financial Engines and Guided Choice, research firm Ibbotson Associates and Morningstar, a leading provider of mutual fund research and data.
Some of the leading names in the retirement industry are moving into managed accounts for 401(k)s.
Sun America, the Los Angelesbased insurer, was the first defined-contribution-plan provider to create managed accounts, working with Ibbotson Associates in the test run that won the Department of Labor's approval in December 2001. Sun America's retirement business has been subsumed under Valic, the annuity provider owned by Sun's parent, American International Group. As of mid-September, AIG Retirement Services, which combines the retirement units of Valic and Sun America, administered $950 million in managed account assets.
Merrill Lynch & Co. also opted for Ibbotson when it launched its managed account product in October 2002. Now 25 plan clients with a total of $1 billion in retirement assets are offering Merrill's managed account product to 22,800 participants. Of these, close to 4,000 -- a 17 percent adoption rate -- have chosen managed accounts. "We have another 21 plan clients signed on to offer managed accounts by January 2005, bringing in another 90,000 participants," reports Diane Talbot, head of Merrill's defined contribution business.
Fidelity Investments teamed up with both an in-house unit with a certifiable level of independence, Strategic Advisors, and with Ibbotson, in March 2003. But thus far only 15 of Fidelity's 24,000 total clients, with a total of about $170 million, have adopted the product. That's a tiny percentage of the giant fund family's $632 billion in defined-contribution-plan assets under administration. Fidelity, for one, has chosen not to offer managed accounts as a default option because its product requires participants to answer enough questions that the process cannot be considered automatic.
Vanguard Group teamed up with Financial Engines in April to offer its first managed account product. Thus far eight plan-sponsor clients have signed on. "We're in active conversation with numerous others," says Bert Dalby, a principal of Vanguard.
New York Life InsuranceMorningstar is announcing its product offering this month. Based on focus groups with about 30 plan-sponsor clients, NYLIM's Salama predicts that some 40 percent of the insurer's 2,100 defined contribution clients will offer managed accounts after the product's rollout in early 2005.
Principal Group announced its managed account offering in May 2004, with Ibbotson providing the independent advice. The new product will appear before the end of the year.
Life-cycle funds and managed accounts both carry a layer of fees on top of the basic investment management fee charged by an individual fund. Typically, life-cycle funds cost an additional 15 basis points, and personally tailored managed accounts cost an extra 75 to 100 basis points.
Though life-cycle funds have been part of 401(k)s since the early 1990s, they came into their own during the 2000'02 bear market, when investors were looking for alternatives to equity funds. According to the Investment Company Institute, the leading mutual fund industry association, assets in life-cycle funds in defined contribution plans grew to $28 billion at the end of 2003, up from $8 billion at the end of 1999.
"Through the 1990s these balanced life-cycle funds did not hold the same appeal as the booming equity markets," notes Sarah Holden, a senior economist at the ICI. "With the bear market, there's been a flurry of interest."
Fidelity, for example, launched its life-cycle portfolios in 1996. By 1999 some 23 percent of Fidelity's plan sponsors included life-cycle funds as an investment option; by January 2004 a whopping 71 percent of Fidelity's plan-sponsor clients offered these investment options. In all, 1.8 million Fidelity plan participants have amassed about $17.3 billion in assets in these vehicles during the past eight years.
In Fidelity's case, more than 20 percent of 1,500 public clients (or about 300) have the life-cycle funds as a default. By contrast, only about 2 percent of Fidelity's some 10,000 corporate plan sponsors (or about 200) do the same. "The tax-exempt market has led the way," reports Steven Deschenes, executive vice president of Fidelity's institutional retirement services unit. "The corporates are following," he predicts.
Vanguard, the No. 2 player in the space, commands about $8.2 billion in life-cycle assets, and third-place T. Rowe Price has $279 million.
Although these are fairly modest asset levels, the newer managed accounts are expected to grow quickly. "At the moment, the number of plan sponsors who are defaulting participants into managed accounts is extremely small," says Morningstar president John Rekenthaler. "But there's no question that this is a topic of great interest right now."
