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DCIO Product Trends

This Strategy Brief is the third in our series of insights regarding the defined contribution investment only (DCIO) market opportunity for investment managers. For this four-part research series, we have partnered with Sway Research to provide insights regarding opportunities and trends to help our clients make informed decisions regarding their strategic distribution efforts. In our first Strategy Brief in this series, we evaluated the DCIO market opportunity. In the second Strategy Brief, we examined the requirements for establishing a sales effort and distribution team to gather DCIO assets. In this Brief, we consider the assets classes in demand in the DCIO channel and examine the impact of regulations on the DCIO marketplace, product structure options and the importance of platform placements in gathering DCIO assets.




As reflected in the following chart, since the start of this decade, Defined Contribution (DC) assets have migrated from domestic large and mid-cap portfolios to Target Date, Target Risk, Small Cap, Stable Value, and International strategies. Sway Research: DC Market Share by Asset Class Change in Defined Contribution Market Share by Asset Class

Category Lifestyle/Pre-Mix GIC/Stable Value Small US Equity International Equity Stock/Fund Window * Bond Emerging Market

of mutual funds.

1999 4.58% 19.91% 1.78% 4.59% 0.00% 2.09% 0.12%

2008 9.49% 24.81% 5.31% 7.89% 2.50% 4.50% 1.01%

% Change 4.91% 4.90% 3.53% 3.30% 2.50% 2.41% 0.89%

Category Balanced Money Market Specialty/Sector Mid US Equity Company Stock Large US Equity

1999 5.74% 2.02% 0.51% 6.15% 23.27% 29.24%

2008 5.75% 1.76% 0.29% 2.17% 15.92% 18.59%

% Change 0.01% (0.26%) (0.22%) (3.98%) (7.35%) (10.65%)

* Stock/fund window: self-directed brokerage account through which a plan participant can invest plan assets into individual securities or a wider range

SEI Strategy Brief: Measuring DCIO Profitability


Target Date and Target Risk (Lifestyle/Pre-Mix Category) funds have more than doubled, with Large Cap US Equity losing more than ten percent over the same time period. The rise in GIC/Stable Value portfolios appears to be more a reflection of the recent market turmoil than a long term trend, although this category continues to control almost 25% of assets. Small Cap portfolios have experienced significant growth in recent years causing some portfolios to close due to capacity constraints and raising demand for open small cap portfolios on DC platforms. In a Sway Research survey conducted earlier this year, DCIO national sales managers were asked to indicate which asset classes were in high demand by intermediaries based on their experience. The overwhelming answer was Small Cap (80%) followed by International (70%) and Mid Cap (40%).

Sway Research: Aligning an Organization for Platform Sales Success Asset Classes in High Demand by Gatekeepers

% of Respondents Mentioning Asset Class


The Pension Protection Act (PPA) added new fiduciary protections to ERISA regulations for default investments. The PPA provides that, in situations where participants have an opportunity to direct their investments but fail to do so, the fiduciaries will be entitled to a "safe harbor" defense if those participant contributions are invested in a qualified default investment alternative (QDIA). Investments that qualify as QDIAs fall into three categories--long-term, short-term, and grandfathered QDIAs. · The short-term QDIA is a default into a money market account for no more than 120 days after the date of the first elective contribution for the defaulted participant. By the end of that 120-day period, the participant's account must be transferred to one of the three long-term QDIAs discussed below in order to maintain the fiduciary safe harbor. The long-term QDIAs are target maturity and target risk funds (i.e., lifecycle or lifestyle funds), balanced funds and managed accounts (i.e., accounts are where an outside firm advises the participant on fund selection and adjusts allocation on a regular basis in return for a fee). The grandfathered QDIA is a stable value investment.



Strategy Brief: Measuring DCIO Profitability


As illustrated below, the projected assets in target date funds is expected to increase 31% by the year 2015. This increase is a direct result of the passage of PPA and the resulting default options available to plan sponsors. Target Risk funds are not expected to increase much beyond their current 9% market share since Target Risk portfolios are less convenient for advisors and require advisor to adjust between funds over time while Target Date portfolios provide a clear glidepath to retirement and require less advisor management.

Sway Research: Best Practices in DCIO Sales and Marketing Projected Assets in Target Date Funds

It should be noted target date and target risk funds did not perform as well as expected during the recent market crisis. However, early indications are that flows into these products continue to be steady.


Few firms are able to achieve success in the DCIO market by offering solutions for only one segment of the market, such as offering institutional mutual fund shares and institutional separate accounts for very large plans, while ignoring the small plan segment by not offering R-shares or a variation of R-shares. Leading record keepers, such as Fidelity, CitiStreet, and Great West offer plans across the spectrum from Micro to Mega. Furthermore, most providers prefer that DCIO managers offer portfolios in a wide range of structures so that an investment manager's products can be slotted into any investment menu, regardless of plan size.

However, there is value in determining which share classes/product structures are most important to DC platforms. In a recent survey by SWAY Research, DCIO gatekeepers were asked to rank product structure preferences. As reflected in the illustration below, a mutual fund with a 25 basis point (bps) 12b-1 service fee received the highest ranking. While this structure historically related to a load-waived A-share, it now generally relates to a variation of an R-share (i.e. a no-load share class with a 25 bps 12b-1fee). American Funds designates this share class "R4." This share class remains important for DCIO managers seeking to do business in both small- and mid-size plans, depending on the preference of the plan sponsor, advisor or consultant. Ranking second in order of preference was the traditional, no-load 50 bps R-share. The 50 bps R-share remains a popular

Strategy Brief: Measuring DCIO Profitability 3

structure for the small plan market, is favored by many retirement advisors, and demanded by most small plan platforms. Yet, few firms offer this option and may be an untapped opportunity.

Institutionally priced mutual fund shares remain a key ingredient to DCIO sales success, as evidenced by an average rating of 7.4, which is the third highest structure preferred. Institutional separate accounts generally do not make economic sense unless the mandate is $100M or greater, thus institutional mutual fund shares continue to comprise a majority of large plan ($100M $250M) DCIO business today. According to SWAY Research, institutional shares will remain a popular choice for large plans ($100M+) for the foreseeable future, although this structure received the fourth highest ranking.1

Meanwhile, Collective Investment Trusts (CITs) ­ are likely to capture market share in the years ahead. CITs, which received an average rating of 6.0, have begun to take hold in the large plan segment, where consultants are recommending them to sponsors as a way to eliminate some of the operating costs associated with mutual funds.

CITs represent an important and growing area of opportunity for asset managers who can take advantage of the CIT structure to enter the 401(k) market or become more competitive within that segment.2 Managers can bring new products to market with relatively short lead times and low startup costs. They can also lower the high costs of managing separate accounts by converting them into collective investment trusts.3 While many DCIO investment managers are just beginning to launch CITs, several early adopters have already developed multiple pricing structures for CITs and offer them with varying levels of management and sub-T/A services and fees.

Sway Research: Best Practices in DCIO Sales and Marketing Gatekeeper Product & Share Class Structure Preferences Product/Class Structure Fund share with a 25 bps 12b-1/ svc fee Fund share with a 50 bps 12b-1/svc fee Instl Fund share with no 12b-1/svc fee Collective Investment Trust Fund share with a 75 bps 12b-1/svc fee Fund share with a 100 bps 12b-1/svc fee Institutional separate accounts Variable insurance trusts Avg. Rating 9.1 8.8 7.4 6.0 5.1 4.8 4.6 1.3

1 2


Most gatekeepers surveyed do more business in the small plan market where R-shares and load-waived A shares are more prevalent.

See SEI Knowledge Partnership's white paper "Collective Investment Trusts: The New Wave in Retirement Investing" (May 2008). CIT's hurdled a pivotal barrier to their adoption in 2000 when the National Securities Clearing Corporation (NSCC) enabled retirement plan participants and record keepers to invest in CIT's using the NSCC's Fund/SERV trade settlement platform.

Strategy Brief: Measuring DCIO Profitability



The portfolio attributes needed to secure platform placements are well-known throughout the industry. They include strong relative performance (especially long-term), low fees and expenses, lengthy manager tenure and high risk-adjusted returns. When examining the key attributes needed to secure placements on DCIO platforms, SWAY Research surveyed national sales managers from 10 leading asset managers to rank selection criteria beyond the basic portfolio attributes. As illustrated in the chart below, manager tenure received the highest rating 8.4. The next three highest rated attributes according to the study were quality of the sales force, quality of due diligence/analytical support and investment philosophy.

Sway Research: Aligning an Organization for Platform Sales Success Importance of Firm & Portfolio Traits to Securing Platform Placements Firm/Portfolio Attribute Manager Tenure Quality of the sales force (adding value to partners) Quality of due diligence/analytical support group Investment philosophy Style purity Strategic business relationships Intellectual capital Fees and expenses Dedicated sales force for specific market Alpha Category Portfolio Sales & Support Sales & Support Firm Portfolio Firm Firm Portfolio Sales & Support Portfolio Avg. Rating 8.4 8.0 8.0 8.0 7.9 7.9 7.9 7.9 7.4 7.4

Those attributes which lead investment managers to gain acceptance on DCIO platforms ­ performance, low fees, and manager tenure -- are also the attributes which generally lead to their demise. Reasons managers lose DCIO mandates include poor 5year performance, compliance or regulatory violations and poor 3-year performance. Although manager tenure was rated highest in the chart below, it trails a couple of performance attributes, as well as compliance or regulatory violations and poor performance by the due diligence support team. This underscores the importance of the support that DCIO managers provide to DC platform partners.

Strategy Brief: Measuring DCIO Profitability


Sway Research: Aligning an Organization for Platform Sales Success Negative Attributes Leading to Lost Platform Mandates Firm/Portfolio Attribute Poor 5-year performance Compliance or regulatory violations Poor 3-year performance Poor service from due diligence support team Manager turnover Portfolio strays from mandate for one or two quarters Poor 1-year performance Poor short-term performance for < 12 months Avg. Rating 9.8 9.1 8.6 8.3 8.1 6.6 6.3 5.3

To get on a platform, a portfolio must be solid on a risk/return and expense level because the gatekeeper has a fiduciary duty to select products that can satisfy thorough screening. However, getting on a platform does not assure sales, as there is likely four or five other products in the same asset class that have met the same screens. Successful DCIO managers provide excellent support to platform gatekeepers and due diligence teams, while also harnessing their sales forces to drive sales to the platform. According to the SEI Knowledge Partnership Strategy Brief II: Staffing a DCIO Sales Effort, investment managers employed a team of 4.7 external sales professionals and 2.8 internal sales professionals on average to cover the DCIO market. These firms also employed an average of 1.7 key account managers and 3 consultant relations representatives, who split their time between the DC and DB business segments.

This third Strategy Brief is designed to provide investment managers with product trends to compare against their products or to consider when evaluating new products targeting the DCIO market. The fourth and final Strategy Brief in this series will address how an investment manager can maintain profit margins on existing DCIO business. To wrap up this series, SEI Knowledge Partnership will host a webinar in the coming months with experts in the DCIO marketplace.

Strategy Brief: Measuring DCIO Profitability



The SEI Knowledge Partnership strives to deliver actionable business intelligence intended to help shape your strategic business decisions. Visit the SEI Knowledge Partnership website at or contact your SEI Relationship Manager for more information on our upcoming SEI Knowledge Partnership Strategy Briefs, research, events and conferences. The SEI Knowledge Partnership is a service of the Investment Manager Services division, an internal business unit of SEI Investments Company. This information is for educational purposes only and is not intended to provide legal or investment advice. © 2008 SEI. For more information on Sway Research and the firm's studies, please visit or contact Chris Brown at

[email protected]

Strategy Brief: Measuring DCIO Profitability



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