Investing February 1, 2022

New Developments in Managed Accounts

Lower fees, more services and new distribution methods might make managed accounts worth a new look for DC plan sponsors.
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Art by Carol Rollo

Managed accounts have evolved a lot over the past several years, with decreasing fees and increasing levels of advice. Now may be a good time for defined contribution (DC) plan sponsors to reassess whether to include them within their employer-sponsored retirement plans.

“We’ve seen tremendous growth in the use of managed accounts in defined contribution plans over the past few years,” says Amber Czonstka, head of product advice and client experience for Vanguard’s institutional business. “Over 70% of participants in Vanguard recordkept plans have access to a managed account.”

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Vanguard defines managed accounts as fee-based advisory services that provide participants with personalized recommendations, advice and portfolio management tailored to their unique needs. In a non-discretionary managed account, the investment advisor requires participant permission before transacting on the account. In a discretionary managed account, the participant provides the adviser to transact on their behalf.

Vanguard’s access figure includes the Vanguard Managed Account Program (a 3(38) service), Digital Advisor (Vanguard serves as a 3(38) discretionary manager) and Personal Advisor Services, which is a non-discretionary managed account.

The reasons for the increased interest: “Price and accessibility, and the robustness we’re able to bring when it comes to advice,” she says. “Advice is no longer just portfolio management, but it’s a range of financial planning solutions—to help think through debt management strategies, save for an emergency fund and think of how to draw down retirement funds in a tax-optimized way.”

Charles Schwab’s managed account availability numbers are also high – 71% of its plans offer managed accounts to participants. “Our standard offering is a combination of point-in-time advice and full discretionary managed accounts,” says Nathan Voris director of investments, insights and consultant services for Schwab Retirement Plan Services in Richfield, Ohio.

Managed accounts provide personalized investment recommendations for a participant based on known data from that either recordkeepers and sponsors know about them, with the potential to add additional information when the participant engages. “The optimization tools and the investment capabilities has really evolved and improved because of the data that is available,” says Voris.

Meanwhile, the fees for managed accounts have been decreasing. “There has been rising interest in managed accounts, and there’s definitely been a reduction in fees for the service over time,” says David Blanchett, head of retirement research for PGIM DC Solutions. “I think that interest will continue and likely accelerate, especially as more plans become interested in providing advice for plan participants.” Average fees for a typical managed account are now about 0.35% to 0.40%, down from more than 0.60% several years ago, he says.

More Targeted Advice

Rather than just providing a portfolio based on more personalized information than a target-date fund (TDF) has, managed accounts are now offering several levels of advice to meet different participants’ needs.

“According to our annual ‘Retirement Saving and Spending’ survey, 71% of participants want help or advice on saving for retirement through their current workplace,” says Lee Stevens, head of institutional sales at T. Rowe Price. “The personalization of advice can be meaningful, especially for participants with more complex financial situations.”

Some managed accounts now are providing guidance on optimal decumulation strategies, Social Security claiming and, sometimes, outside assets, Blanchett says. “They’re providing more holistic guidance than earlier versions of the service,” he explains.

The way the advice is provided can also vary depending on how much the participant wants to engage with the plan. Vanguard, for example, offers several levels of advice.

“Our managed account fee structure varies based on the service,” says Czonstka. Digital Advisor, with an advisory fee of 0.15%, is designed for investors seeking advice through an all-digital platform. Personal Advisor Services, with an advisory fee of 0.30%, complements a high-tech digital experience with advice from a Vanguard Personal Advisor.

The Vanguard Managed Account Program (VMAP), powered by Edelman Financial Engines, offers a personalized retirement plan with an investment strategy and ongoing professional management with a retirement income feature. VMAP fees are based on account assets managed. The firm also offers Vanguard Situational Advice, which provides a one-time, adviser-led consultation to help with particular life events, such as a financial windfall, marriage, expanding family or job change. The one-time fee can vary if the plan subsidizes all or part of the fee for participants, Czonstka says.

Younger participants who are trying to figure out how to juggle multiple financial priorities might want a digital interaction, but as their needs become more complex—for example, as they’re trying to estimate health care costs in retirement—they may want to choose to engage an adviser, Czonstka says. “We believe that advice is a constantly evolving product,” she notes.

Schwab also offers several levels of advice in its managed accounts.

“If you want to come in and use a digital tool and get investment and savings recommendations on your own, you can do that through the advice managed account program digitally,” says Voris. “You can also have a conversation with a financial coach that can go into any direction that the need arises—financial planning, estate planning, etc. It depends on what the individual wants to get out of it.

“Most of the time, the plan sponsor chooses the full suite of services for managed accounts, and it’s up to the individual participant to decide how they’d like to engage,” he continues. “It really is a gateway to engagement—a person goes in and has that digital exchange and then the door opens to explore all the other goals and objectives they might have.”

The participant starts by providing information through a digital tool or by talking with a financial coach, then Schwab uses Morningstar tools to recommend the savings rate and investment portfolio. The participant then decides how to implement the guidance—choosing either a point-in-time solution or deciding that they want to adopt a discretionary solution with ongoing management. “The solutions are presented side by side and they can see the dollar amounts,” says Voris. “We are putting that decision in the participants’ hands.”

The newest development is adviser managed accounts. “It’s very similar to what you would have with traditional managed accounts, except the plan adviser serves the role in the portfolio construction and engages with the participant,” says Voris.

The plan adviser takes on the fiduciary role and often knows the plan sponsor and its culture and how to engage at the participant level. “This is new, but if you ask me the No. 1 trend, I think a big portion of the managed account growth will be in the adviser managed account space,” he says.

Managed Accounts as a Dynamic Default

In the past, some plans would offer either TDFs or managed accounts. Now, more plans are offering both options to meet different needs through a participant’s life stages.

“I’m a big fan of target-date funds, and they have dramatically improved investment outcomes for participants in defined contribution plans,” Blanchett says. “But target-date funds are basically just based on your age.” Managed accounts can factor in other criteria to determine the risk for your portfolio, such as income, account balance, savings rate and outside assets, in addition to age. “It allows for a more personalized portfolio,” he says.

Younger participants who want a low-cost solution without a lot of engagement may only want a TDF. “You don’t see as many risk-level differences when people are younger, but they widen the older someone gets,” Blanchett says. Managed accounts, on the other hand, cost more but provide more personalized portfolios and advice.

“We believe that target-date funds and managed accounts exist in harmony,” Czonstka says. “Target-date funds are an elegant solution when [participants are] not engaging with us and sharing information about themselves. As the participant is willing to share more about their financial picture—their holdings outside of the financial plan, the struggles they’re dealing with—then we can tailor the portfolio and glide path to the participant’s needs.”

Some plans are starting to offer managed accounts as the default investment for older plan participants.

“There is growing awareness of dynamic qualified default investment alternatives [QDIAs], which merge two QDIAs: a target-retirement date or balanced investment option and a managed account service,” says Stevens. Rather than having a TDF as the default for all ages, which many plans do now, the default may be the TDF for younger participants, but then it might become the managed account for participants age 50 or older.

“Older plan participants who have higher account balances and more outside holdings tend to benefit most from managed accounts,” Stevens says. “Younger participants with less complex financial situations are well-served by target date funds.”

More Advice for Retirees

Managed accounts are also expanding to provide more advice to participants after retirement, which continues to keep them engaged in the plan even after they leave their employer.

“Retirement income is a hot topic right now, and advice in managed accounts is a great place to help solve for income and help people achieve those goals from a decumulation and retirement income perspective,” Voris says. “The decumulation and withdrawal strategy is a very personal conversation. When a person reaches that point in their career, they often seek out advice.”

Blanchett says one way plan sponsors can keep participants engaged with the plan even after they retire is by providing an extra level of advice to help them manage their money after they stop working. “It’s not only how risky the portfolio should be, it’s also how much you should spend, what accounts to draw down first and guidance for assets that aren’t in the managed account,” he says.

Investing January 31, 2022

Plan Sponsors Still Aren’t Embracing ETFs

Many defined contribution plan sponsors are focusing on lower fees, which is a selling point for exchange-traded funds, but there are other ways sponsors can cut costs.
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Exchange-traded funds (ETFs) have failed to gain widespread use in defined contribution (DC) plans, although they have become popular among individual investors.

Morningstar Director of Personal Finance Christine Benz has developed a series of hypothetical portfolios for savers and retirees, and explained in a recent article that while they all posted strong gains last year in absolute terms, “the ETF portfolios crushed their mutual fund counterparts.” Given such results, would retirement plan participants fare better with ETFs than with mutual funds?

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Morningstar Head of Global ETF Research Ben Johnson says the article is making single ETF and single mutual fund comparisons, so investors can’t make generalizations about ETF performance based on that. However, he says a generalization that Morningstar can see and say with a high degree of confidence is that over longer periods of time, lower fees lead to better outcomes.

“ETFs tend to have lower fees than many mutual funds, which might lead to longer-term outperformance,” Johnson says. “But that’s not unique to ETFs. There are low-cost mutual funds, especially in retirement plans.”

Kristen Carlisle, general manager of Betterment’s 401(k) business, says mutual funds have higher fees than ETFs, and many mutual funds in DC plans are actively managed and require in-depth analysis. She adds that research has shown there’s rarely a big improvement in performance from active management.

“A majority of actively managed funds lag in performance compared to passively managed funds over nearly every time period,” Carlisle says. She adds that ETFs allow for more diversification in investors’ portfolios. “ETFs allow for far more diversification than single stocks and must adhere to the same diversification requirements as mutual funds,” she explains. “Because ETFs typically aren’t over-concentrated in any specific company, sector, or country (unless specifically called out in the fund offering prospectus) you’ll be spreading your investments across multiple assets and therefore limiting your exposure to specific risks.”

A few DC plan providers offer all-ETF 401(k)s, including Betterment. Carlisle says the biggest reason ETFs typically aren’t included in employer-sponsored plans is that the market is dominated by players incentivized to offer certain funds.

“Many retirement plan providers are mutual fund companies, and plans are sold through their distribution partners,” she explains. “There are fees embedded in mutual funds that facilitate payments to every party involved in the sale. That structure has been in place nearly since the inception of 401(k)s.”

Carlisle says there are also existing technology limitations. “Most recordkeeping systems were built decades ago and are designed to handle batch trading, not intraday trading,” she says.

Johnson also cites the operational issue that has prevented widespread availability of ETFs in DC plans. “Because ETFs trade like stocks throughout the day, the mechanics of trading, clearing and allowing for investments in fractional shares is difficult to solve in traditional recordkeeping platforms,” he says.

However, Carlisle says technology is catching up and there is rising interest from younger and newer investors to include ETFs in their retirement plans.

Still, according to Johnson, there are two issues with ETF use in DC plans that will persist. “The first, more fundamental issue is that many of the benefits of ETFs go away when used in the confines of a tax-deferred retirement account,” he says. “A reason ETFs appeal to many individual investors and financial advisers is they tend to be more tax-efficient than open-ended mutual funds. But that becomes a moot point in a tax-deferred account.”

Lower fees are still a benefit of ETFs, but they might be less of a benefit inside a DC plan where many investment menus already feature low-cost index funds, Johnson adds. “So if a DC plan uses ETFs instead, it might be just getting a like-for-like swap, so there wouldn’t be a reason to move out of low-cost index funds.”

Another thing to keep in mind, according to Johnson, is that many plan sponsors are moving away from mutual funds toward collective investment trusts (CITs), which also boast lower fees. “There’s a tug of war between mutual funds and CITs, and CITs are winning,” he says.

The other issue with using ETFs in DC plans is liquidity, Johnson says. “ETFs trade like stocks so they can be exchanged all day long,” he explains. “That might be viewed unfavorably by sponsors because they don’t want to see participants day-trading their nest eggs.

“For all these reasons, we’ve long been skeptical ETFs will make it in the DC plan space,” Johnson says.

Asked about the concern over retirement plan participants day-trading with their savings, Carlisle says Betterment’s solution addresses that through goal-based investing, taking out the guesswork for participants about how to invest their funds. Betterment’s platform includes personalized investment advice for participants.

“We guide them to think about what life they want in retirement and we tell them how best to get there rather than leaving it up to them to pick their own funds, as traditional recordkeepers do,” she says. “There are arguments that ETFs are confusing and that they can be distracting because of intraday trading, but technology can eliminate those concerns.”

Johnson says, in his opinion, ETFs could have a role in smaller plans—those that might not have sufficient assets to qualify for the lowest-cost share classes of mutual funds. “And there’s no minimum investment requirements for ETFs,” he adds.

A way ETFs might find their way into the DC plan space more broadly is through target-date funds (TDFs), Johnson says, noting that at least one fund provider is offering ETFs in TDFs. He says the product was specifically designed to cater to smaller plan sponsors.

To get ETFs to break into DC plans comes down to who is asking for it and demanding it, Carlisle says. “As I said, younger and newer investors want ETFs in their retirement plans,” she says. She also says it will take “continued education for plan sponsors about the value of ETFs and how they differ from mutual funds, and about making choices that are best for employees.”

Carlisle adds that cost is another factor in favor of ETFs in DC plans. “People are paying attention to their retirement plan fees and litigation is on the rise,” she says. “This will put a spotlight on the difference between fees for ETFs and for mutual funds.”

“Plan sponsors should understand it’s important to pay attention to cost. It affects how much participants can save for the future,” Carlisle says. “We believe in ETFs because they are low cost without sacrificing performance.”

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