There’s growing pressure on money managers to either get bigger or sell their firms driven by two big trends which are rampant in 401k and 403b plans – the move to passive investing and target date funds (TDFs). What are the consequences of this trend for plan sponsors and advisors?
As detailed by a large DC advisory group, there are a number of factors driving smaller boutique asset management firms to close a fund or even sell the company. The drive to passive investing with the focus on fees, one of the easiest factors to control that affect results, is deadly to active managers and can even hurt margins at firms that offer passive options. DC plan sponsors believe that they are better protected from lawsuits using passive funds although the most important factor may be revenue sharing subsidizing administration and other services.
The massive move to TDFs in DC plans can hurt money managers which have a much smaller pool of assets to draw from. And pension derisking may have the same effect as money moves into annuities which are just another form of asset allocation investments like TDF where a 3rd party selects the underlying investments. The move to CITs can have the same effect.
For plan sponsors and their advisors, the result of M&A among asset managers may be both good and bad. There may be fewer options but we are learning that less is more for DC menus – fewer choices can result in better choices. And while indexing seems attractive in bull markets, smaller nimbler firms may be better positioned in down markets even if their fees, including the cost of running the firm and distribution, are higher.
At the heart of the issue is whether passive is better than active money management for DC plans. The answer is much more complicated than the question implies. Certain asset categories like large cap value funds may be better suited for passive but that’s not true for all. And while a majority of active money managers may have trouble beating their benchmark, that percentage is lower when certain filters are applied like the size of the firm and whether their managers invest their own money in the fund according to research by American Funds.
So while fewer options may seem like a good thing for DC plans as does the move to passive with more assets in index funds for top 100 DC plans, there’s an important role for active management, and even boutique firms, especially when the market turns.
