New research from Cerulli Associates takes a close look at lifetime income products and alternative investments in target-date funds brought about by the SECURE Act and the DOL.
The Boston-based research and consulting firm claims, “the strategic incorporation of one or both could potentially help providers deliver superior long-term outcomes for plan participants and differentiate themselves in a market dominated by a small handful of low-cost providers.”
Specific provisions in the Setting Every Community Up for Retirement Enhancement (SECURE) Act helped remove associated barriers to adoption by defined contribution (DC) plans and have significant implications for retirement providers, plan sponsors, and participants.
The Act is designed to facilitate the inclusion of lifetime income products (annuities) in 401k plans and other DC plans that do not typically feature lifetime income products.
According to Cerulli, the majority (92%) of firms expect managed payout options and annuity allocations will be incorporated into future target-date fund series.
The market volatility in the first quarter of 2020 may also serve as a catalyst for lifetime income adoption by DC plans as nearly two-thirds (63%) of target-date managers say this period of heightened market volatility will increase client demand for guaranteed investments.
Cerulli suggests providers of lifetime income products leverage market downturns to illustrate their downside protection benefits.
Private equity inclusion
In addition to annuitization, the use of alternative investments such as private equity funds may change.
The Department of Labor (DOL) information letter, released earlier this year, offers regulatory guidance related to the use of private equity funds within professionally managed strategies (e.g., target-date funds, target-risk funds) that may serve as a DC plan’s qualified default investment alternative (QDIA).
“Although the letter represents a key step toward giving private equity a larger presence within the DC product landscape, adoption will likely occur at a gradual pace as providers look to craft products, educational materials, and messaging for the DC market,” Shawn O’Brien, Cerulli senior analyst, said in a statement.
In the coming months, Cerulli expects plan sponsors and retirement plan providers to engage in more detailed exploratory discussions regarding the inclusion of private equity in multi-asset-class products such as target-date funds.
Providers looking to incorporate allocations to private equity should remain aware of the unique demands and constraints of the DC market.
“Private equity funds are typically characterized by infrequent pricing events, low liquidity, relatively high management fees, and complex investment structures,” O’Brien added. “Conversely, the DC market—litigious in nature—is notoriously fee-sensitive, and the product landscape is dominated by simple, transparent, low-cost investment vehicles.”
Cerulli believes it is perhaps most critical for providers to clearly demonstrate to plan fiduciaries how allocating to a certain private equity strategy within a professionally managed product can improve long-term outcomes for plan participants on a risk-adjusted, net-of-fees basis. Asset managers and consultants/advisors looking to offer professionally managed products that allocate to private equity should be prepared to educate plan sponsors on the fundamentals of private equity investing.
“It may take time for many plan fiduciaries to gain a sense of comfort with private equity investments, and therefore, thorough educational and informational engagements may be a necessary precursor to adoption in a DC market where private market investments are rare,” O’Brien concluded.
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
