Managed accounts can be a powerful tool for plan participants if implemented with complete financial information at a reasonable cost. The basic premise of a managed account is the construction of a completion portfolio with participants' defined contribution (DC) assets, built around their whole asset profile and individual circumstances. We posit that managed accounts, customized at the participant level, have the ability to improve retirement outcomes if designed and implemented appropriately.
The Department of Labor (DOL) has given plan sponsors the choice of three offerings that may be used as a plan's qualified default investment alternative (QDIA), where participant money can be defaulted if a participant fails to make an investment election. A managed account is one of the offerings, along with life-cycle or target-date funds (TDFs) (age based dynamic asset allocation funds), and balanced funds (static asset allocation funds). Each of these three options offers a professionally managed, asset allocation-based framework. The vast majority of sponsors utilize TDFs as default options because they are simple, cost effective and dynamic in that the asset allocation changes over time, de-risking as retirement approaches. The static nature of balanced funds makes them less attractive than TDFs, and few plan sponsors utilize them as the QDIA, according to Towers Watson's 2014 DC Plan Sponsor Survey. Managed accounts have had limited use as the default option for plan sponsors, although they have gained traction as a supplemental advice tool that participants can access independently for guidance. Figure 1 illustrates the basic premise of each option, along with considerations.
Figure 1. The three QDIA options
Plan sponsors recognize the vital nature of selecting the correct QDIA, and are tasked with both regulatory scrutiny and reminders to evolve how they approach the design, selection and monitoring of the default option. The DOL released tips in 2013 to encourage sponsors to evaluate their TDF offerings. More recently, the U.S. Government Accountability Office (GAO) released a view on managed accounts, calling for additional scrutiny as outlined in the box to the right. Further, the DOL has commented that they will consider the GAO's feedback, which may potentially lead to guidance for sponsors who utilize managed accounts. We agree with this heightened level of evaluation and support efforts aimed to improve default solutions. The bottom line is that sponsors have a number of options, and it may be prudent to revisit, reevaluate and reconsider their QDIA offerings.
A Unique Retirement Service
Unlike its counterparts, which are funds, a managed account is a service that allows participants to provide personal information and receive individualized asset allocations that are managed on an ongoing basis. By offering customized, holistic retirement advice and portfolio implementation, managed accounts provide an individualized service for participants who are tasked with directing their own investment accounts — a service that is distinct from TDFs. Once added to a DC structure, participants typically have access to both an advice tool (advice), where participants remain responsible for implementing an asset allocation, and a professional management service (managed account), where the provider has full discretion and acts as a portfolio manager for participant accounts. Managed account providers leverage a plan's core investment lineup to create efficient, diversified portfolios for individuals. Providers also increase visibility and consideration of income planning by attempting to move participants away from accumulated balance metrics toward income-based metrics. The income planning is supported holistically, with many providers taking into account factors such as retirement goals, minimum income levels, outside assets, social security and asset location for tax considerations. Utilizing a managed account often leads to positive non-investment behavior as well. For example, a recent study by Morningstar found that participants increased their savings rates by nearly 28%, an average of 2% of their salary, after using managed accounts/advice.i
Managed accounts can also offer unique benefits by accessing asset classes and strategies outside of the core investment lineup. These would include strategies that have attractive properties from a portfolio construction perspective, but may be too esoteric to add to a DC structure as a stand-alone option for fear of participant confusion or misuse. Examples may include private real estate, long-duration bonds, annuities and diversifying strategies. The overall allocation and the liquidity of these extended asset classes may be managed directly through the managed account.
Improvements Can Be Made to Better Protect Participants in Managed Accounts
"Managed accounts can be useful services and may offer some advantages for [DC plans]. They build diversified portfolios for participants, help them make investment decisions, select appropriate asset allocations and estimate the amount they need to contribute to achieve a secure retirement. Given these potential advantages, it is no surprise that the number of managed account providers has grown and that plan sponsors, seeking to provide the best options for plan participants, have increasingly offered managed accounts. The extent to which managed accounts benefit participants may depend on the participant's level of engagement and ability to increase their savings. Despite the potential advantages, better protections are needed to ensure that participants realize their retirement goals. These protections are especially important as additional fees for this service can slow or erode participants' accumulated retirement savings over time."
Evolved Solutions Target Improved Outcomes
The case for managed accounts has strengthened over time as provider service offerings have improved. The aggregation of outside assets, for example, has historically been handled through manual-user entry. Currently, a number of providers have partnered with or purchased data aggregation services that automatically pull all participant financial information into one place, allowing for real-time updates and an improved user experience. Some providers are even willing to give guidance on outside assets at the asset-class level.
Providers have also improved how they help participants prepare for and execute the eventual spending of accumulated retirement assets; although, these drawdown tools are still early in their evolution. Specifically, providers have markedly different philosophies regarding the goals and implementation of a retirement spending program, with some services continuing to model personalized allocations, while others move all participants to a bond-heavy portfolio to target income stability. Recognizing that investable assets are not the only source of retirement wealth, many providers have rolled out Social Security guidance as a way to generate additional potential income through optimizing strategies, such as when to begin benefits. There is some disagreement concerning whether Social Security advice should be provided through the tool itself or offered alongside the tool through expert call centers, but the majority of providers are moving in the direction of at least offering some level of advice.
Adopters Are Plan Sponsors, Not Participants
The benefits of managed accounts and the improvements made over time have led to improved adoption numbers among plan sponsors. As Figure 2 shows, 55% of respondents in Towers Watson's 2014 DC Plan Sponsor Survey offer managed account services, while 70% offer investment advice. Although the number of plan sponsors offering managed accounts has increased, usage has remained low. Vanguard's How America Saves surveys, spanning plan years between 2009 and 2013, reported managed account usage of 6% to 7% each year, while the percentage of participants offered access to managed account services climbed from 36% to 52%.ii
Figure 2. The use of education/advice for retirement planning and investing
Click to enlarge
Source: Towers Watson's 2014 Defined Contribution Plan Sponsor Survey
Why are managed accounts underutilized? In part, participants may be unaware of the offering, as communication campaigns supporting managed account rollouts have been shown to have a material impact on adoption. But perhaps the major factor driving the lack of adoption is fees.
Fees Are a Roadblock to Adoption
Comparisons are often made between managed accounts and TDFs, given that both offer asset allocation solutions to DC participants. As Figure 3 shows, when selecting a TDF, sponsors clearly indicated that the glide path used was the most important consideration. Managed account providers may claim that they improve asset allocations by considering individual circumstances, but the second-most important consideration for sponsors — fees — is clearly working against them.
Figure 3. TDF selection considerations
For large plans, we often see sliding fee scales for managed accounts starting at around 50 basis points (bps), with higher fees put forward for smaller plans. This is in addition to fees from the underlying funds. From a participant perspective, if they have access to a managed account, they can also utilize the provider's advice module. Advice is generally free for participants, so they should question what they get relative to the advice when implementing the managed account. They are getting the ongoing management but are paying upward of 50 bps. Since participants have access to the majority of the provider's services at no cost through the advice tool, is the additional layer of fees reasonable? Some participants may consider this a suboptimal trade-off and would require a lower fee to consider using managed accounts for their ongoing portfolio management.
Sponsors that offer managed accounts have to decide how they want to implement — as an opt-in or opt out service. As Figure 4 shows, managed accounts have not gained traction as a QDIA. Given that QDIAs often receive a majority of plan assets and that many defaulters are not engaged, it is reasonable that sponsors would not want to expose those participants to a default option that adds material fees. This is particularly true given that many new hires default and often have less-complex financial situations where a lower-cost TDF would sufficiently meet their needs.
Figure 4. Qualified default options
Advancing Managed Accounts as a QDIA
When considering whether implementing managed accounts as a QDIA is reasonable, fees are typically at the forefront. The GAO statement specifically calls out fees as an important factor because higher fees can erode long-term savings. We agree with this statement and believe it is vital to get the value-for-fee proposition right. Towers Watson has had success negotiating lower fees on our clients' behalf, either directly or through arrangements leading to discounts, but still not to the point where we would consider them a superior default investment to TDFs. We acknowledge that the range of additional services offered in addition to asset allocation, as discussed earlier, should have added costs associated with them. Still, we believe that the managed account industry needs to lower fees before we would expect meaningful adoption of managed accounts as a QDIA.
Fee quotes tend to be lower for managed accounts if a sponsor decides to implement them as a default option (typically discounts of 10 bps or more). This is in recognition of a status quo bias, where defaulters will often tend to leave their money in the QDIA. While this does not push fees to a low enough level to compete with TDFs as a plan's QDIA, there are other considerations that can make managed accounts relatively more attractive (compared to TDFs) as a default solution.
One consideration is that younger participants have less complex financial situations. So managed accounts, and the fees they bring, may not be desirable. A solution would be to route younger participants into an allocation based solely on age, transitioning them to a managed account as they develop more complex circumstances approaching retirement. Younger participants would then not pay the full cost of the managed account. There are a number of ways to potentially implement this concept that appear consistent with current regulations and discrimination testing as long as the solution remains investable for all participants. The regulatory environment could also change to more explicitly permit such a QDIA structure, similar to the recent Treasury- and DOL-issued guidance that facilitates inclusion of an annuity benefit in a TDF.
Another element that could make managed accounts more attractive would be greater utilization of strategies outside of the core investment lineup. Defined benefit (DB) plans have outperformed DC plans consistently, with lower risk, as shown in Figure 5. One of the main drivers of the difference is the use of professionally managed portfolios in DB plans, which can incorporate investment strategies that are harder to implement within the DC operational structure. Many of these issues can be overcome if investments are implemented through a managed account that allows for more efficient participant portfolios.
Figure 5. DB plans' outperformance of DC plans
Source: Towers Watson
As noted earlier, the evolution of retirement spending tools will also strengthen the proposition for managed accounts. Asset location is an area that is beginning to be explored in more detail as a source of income maximization. Some services have discussed tax loss harvesting, for example, as a way to utilize external assets that have declined in value in order to generate tax deductions.
Lastly, we also expect managed account providers to become leaders in retirement distribution. The success of managed accounts in improving retirement outcomes for participants will depend on their continued evolution in offering professional advice to help participants make complicated decisions regarding Social Security, drawdown strategies and the use of institutionally priced annuities.
The Right Direction
Managed accounts have advanced and can provide useful benefits for participants as they aim to holistically plan for their retirement. With the objective of successful retirement outcomes in mind, managed accounts are helping the industry evolve from accumulation maximization to solving the retirement income puzzle. Still, progress is needed, especially with regard to fees, to get from where the industry is today to what we would consider an ideal managed account offering for a DC plan's QDIA.
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