Managed Accounts More Appealing for 401(k)s

A new trend may be on the horizon, one that could greatly improve employee retirement readiness. According to sources, “high-tech” managed accounts, designed from a breadth of individual data, could be key to maximizing plan participants’ saving efforts.

401(k) plans have, indeed, begun using the accounts more—a change just this year—although probably not as the qualified default investment alternative (QDIA), some sources note. Among plans that do not use managed accounts as a QDIA, personalized employee engagement is driving increased use, says Jim Smith, vice president of workplace solutions for Morningstar Investment Management. In addition, plan consultants are warming to managed accounts and increasingly recommending them as a QDIA.

Heretofore, plan sponsors had resisted the accounts, owing to additional fees for the extra advisory services they provide—services frequently lost on participants, who had neglected to use them—and a steeper learning curve than is required with target-date funds, the overwhelming choice for QDIA, says Steve Dorval, managing director of retirement and investment strategy at John Hancock Retirement.

Still, these experts and others believe that, thanks to advances in technology, plus recognition of the definitive retirement savings goal—sustainable income—and of the limited ability of target-date funds (TDFs) to get people there, the day for managed accounts may have come.  

Target-date funds have, of course, been a boon to defined contribution plans, providing participants with assurance that someone more knowledgeable will monitor their holdings, periodically reweighting the stock-to-bond ratio as their retirement nears. Where the funds fall short, though, is that an investment strategy based on age alone, while better than no strategy, can’t produce the results of a customized one, Dorval says.

“The more data you can get, the better job you can do for a plan’s participants,” Smith agrees.

Customization has always been the managed account’s strength, and now the high-tech accounts can get as personal with participants, financially speaking, as they will allow. Besides their salary, age and contribution rate, the account factors in further income and assets (including a spouse’s), state of residence—important, Smith says, because of tax implications—and other relevant data, resulting in a portfolio that responds to the owner’s unique needs as well as to the markets.

But in spite of their potential to outperform target-date funds, managed accounts have often failed to deliver, partly for the same reason other products have failed—and, contrarily, why  target-date funds have their success—participant inertia. According to Dorval, “Because of the inertia of so many participants, and what I might argue is a lack of investment and user interface and experience with some of these products, the reality is [providers] don’t gather that much more data than what you get in a target-date fund. So I think plan sponsors and advisers have said, ‘Gee, are we really getting anything extra for what we’re paying?’”

What may be about to change this is that mobile technology and the “robo” revolution in investment-advice services have sparked user engagement, demonstrating how well an appealing auto-engagement vehicle tied to data collection can work.

With John Hancock’s managed account, “participants sign up for the aggregation engine, provide information about their current accounts and allow us to see that data; then we can apply our analysis to that, which can help to refine the recommendations, both upon how much you’re going to need to live on in retirement and what’s the optimal approach to both a saving strategy and an investment approach to achieve that goal,” Dorval says.

Bank of America Merrill Lynch’s managed account service recommends an initial contribution, asset allocation and specific investments based on how much data the participant supplied. The participant may thereafter provide further data and/or adjust his life expectancy, projected retirement age and retirement income goal. Like many other managed accounts, depending on options selected, this one can be rebalanced and reallocated periodically to reflect participant updates. The person may seek out advice online or from a call center.

The above services set managed accounts apart from target-date funds and results cannot be compared, says Gary DeMaio, defined contribution product manager for the company. “Part of the problem is that there is still confusion around what managed accounts are and how they are different than TDFs. A managed account is a personalized investment advisory service while a TDF is just a fund,” he says. 

Plan advisers especially have done a lot of due diligence to put all the pieces together and have arrived at a more favorable opinion of managed accounts, says Smith. “A number of the defined contribution plan consultant community have, in the last 12 months or so, come around and said, ‘Managed accounts really have some strong benefits as an offering or a QDIA.’ he says. He believes this has led more plan sponsors to offer the accounts.

Some large and mega plans have made managed accounts their QDIA, he says, noting that the decision usually reflects other choices the plan sponsor has made such as regarding plan philosophy or platform—whether it is open, and consequently more receptive to the accounts as default, or closed. “In our case, the provider, and its philosophy about what makes for a good QDIA, ends up driving whether or not managed accounts will be more popular as a QDIA,” Smith says. “Those that are strong advocates of target-dates[—e.g., those using custom funds—]will probably still continue to use them, for the most part, as their QDIA.”

Whether participants take advantage of the services or not, resulting fees can be a drawback to plan sponsors considering managed accounts as their plan default. Dorval, however, says this concern can be unfounded. “[Education hasn’t done enough to explain the] perception that managed accounts have to be more expensive than target-date funds because usually there’s an additional fee for them. I say ‘perception’ because pricing, at the end of the day, is a) negotiable and b) in the eye of the beholder.”

“Whether or not a managed account is more expensive depends on what you’re comparing it with,” Dorval continues. He cites the example of a plan with a managed account averaging participant fees of 40 basis points (bps) along with an indexed lineup averaging 40 bps. “All in all, participants pay 80 bps; that’s less expensive than many target-date funds in the marketplace,” he points out.

“If you’re comparing with a target-date fund series that’s, on average, 1%, managed accounts are actually cheaper. If you’re comparing it with Vanguard, at 19 bps, it’s more expensive. So the reality is much more complicated than general perception,” he says.

Bank of America Merrill Lynch eliminates the fee barrier by not charging participants for its managed account service at all, says DeMaio. “In fact, with plans using automatic enrollment on our platform today, the service is a more popular default investment than TDFs, by more than a two to one margin.”

If the company meets resistance for its product, this is usually in the form of “a misunderstanding of what managed accounts are and what they can deliver to their employees,” DeMaio says. “Sixty percent of our plan sponsor clients are offering [them], recognizing the benefits of making advice available to their employees.”

He also speaks to the question of learning curve: “The perception is that managed accounts are complicated, but once we illustrate how easy it is for employees to engage and utilize the service, they usually move quickly to implement it.”

Looking to the future, Bill Van Veen, director of interactive platform management, also at Bank of America Merrill Lynch, believes technology-enabled accounts will focus even more on personalization, be that more guidance about inputs such as income replacement ratio, life expectancy, health care expenses, Social Security optimization, or outputs with more targeted recommendations about deferral rates and portfolio placement.

“Holistic financial wellness will continue to be a key focus,” he says. “Therefore assessing the results of the managed accounts and their impact across other financial measures, and integrating those results into a participant’s overall financial wellness assessment, will be critical.”

Smith notes that, as managed accounts evolve, they are acquiring the ability to prescribe a draw-down strategy, post-retirement—one that will recommend which income source to draw from first, to maximize a portfolio’s value while best achieving the participant’s desired retirement lifestyle. “[These features] make managed accounts more and more attractive to retirement plans and plan sponsors,” he says.

Dorval envisions what he calls “the optimal managed account,” where advanced aggregation engines will enable the participant to provide credit card account and bank balance information once, after which John Hancock will “directly interface with the other financial institutions to keep all of their information fully up to date and conduct analysis on this, [in] real time,” Dorval says.

The account will also have a broader usefulness than purely related to investments, employing additional information to analyze the participant’s spending and saving behavior then extrapolating how much he will need to live on in retirement, Dorval continues. “It will help the participant define his financial goals and liability,” then determine how current cash-flow habits could be affecting his retirement readiness, one way or the other, and make suggestions accordingly, he says.