Fund companies see target-dates adding annuities in future: Report

The vast majority of target-date fund managers expect annuities and managed payout options to be incorporated into the products in the near future, a recent survey found.

Only 8% of product providers say they don’t expect the widespread inclusion of those features in target-date funds, according to a report Wednesday from Cerulli Associates.

Thirty-eight percent said the use of annuities within those products is highly likely, and another 54% said it is somewhat likely, the report noted. And 46% said managed payout features are highly likely, while an equal percentage said those are somewhat likely. Cerulli surveyed 24 target-date managers during the second quarter, representing 95% of the industry by assets.

Fund providers also said they see a rise in custom products, with 42% predicting that target-date funds will increasingly be customized at the participant level, Cerulli found. Further, 38% said more products will include a transition to managed accounts -- a feature that record keeper Empower Retirement added to its services in 2017.

A similar percentage of fund companies also said products will use environmental, social and governance criteria in their investment processes, though 29% said that is unlikely.

The wider incorporation of annuities in DC plans is expected given provisions in the SECURE Act that alleviate some of the fiduciary stressors plan sponsors face around selecting products and insurers. The Department of Labor also recently added a rule that takes effect next year that will require annual account statements to include an estimate of lifetime income payments, based on 401(k) balances. That development could make 401(k) savers more familiar with annuities in concept.

ILLIQUID HOLDINGS

Another way that target-date funds could change in coming years is through the use of private equity holdings. In June, the DOL clarified in a letter to Pantheon Ventures that 401(k) plans can include private equity as a component of multi-asset investments.

While such holdings technically were already allowed in defined-contribution plans, the DOL’s stance bodes well for the gradual inclusion of private equity as a small component of target-date funds, according to Cerulli.

None of the fund managers the company surveyed during the second quarter include any private-equity holdings in their ’40 Act products. But about 6% of defined-contribution investment-only firms use private equity within some multi-asset class products, the research firm found. About 1% of DC plans include custom target-date strategies with allocations to private equity, according to data from the Defined Contribution Institutional Investment Association cited by Cerulli.

One of the biggest hurdles to including private equity in 401(k) investments will be the cost, the report noted.

“It’s definitely one of the most inhibiting factors,” said Shawn O’Brien, senior analyst at Cerulli.

Among plan sponsors the company surveyed, 92% said cost was their top consideration in choosing target-date funds. Fiduciary liability is almost certainly a factor in that, given the ferocity of 401(k) fee litigation of late.

The costs associated with private equity and illiquid alternative investments are high compared to the cost of traditional equity and fixed income, O’Brien noted.

Some of the most likely candidates to consider such holdings could be large employers that have legacy defined-benefit plans, which often include small allocations to private equity. At the end of 2018, corporate DB plans held average allocations to private equity and other alternatives of 6% and 5%, respectively, according to Cerulli’s report.

After such employers move to include those investments within their 401(k)s, “larger plan sponsors that have that same expertise within their investment committees and may be looking for a custom target-date for their plan will explore adding private equity or illiquid alternatives as a sleeve within that investment,” O’Brien said.