The $7 trillion defined contribution market could becompared to an aircraft carrier—the plodding behemoth of the oceanthat doesn't change direction quickly, but moves a lot of waterwhen it does.

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“The DC market is a slow-moving market,” says Greg Porteous,head of defined contribution intermediary strategy at State StreetGlobal Advisors. “But when it does move, it moves in a bigway.”

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Target-date funds serve as perhaps the bestexample of Porteous’ assessment. The TDF market held $880 billion in assets at theend of 2016, a record high according to Morningstar.

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The safe money says that record will again be eclipsed thisyear. Just a decade ago, right after the Pension Protection Act of2006 certified TDFs as a qualified default investmentalternative in 401(k) and other DC plans, TDFs held less than$8 billion.

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It’s hard to imagine any other product innovation coming closeto claiming that impact. By 2015, TDFs accounted for 20 percent ofall assets in 401(k) plans, according to the InvestmentCompany Institute.

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That level of explosive growth has asset managers like SSgAunderstandably chomping at the bit to put newer, lower-cost optionsin front of plan sponsors in the effort to retain and capture moreof a market that shows no signs of slowing.

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While SSgA has been managing defined contribution assets fornearly four decades, it has only been in the TDF market for aboutseven years. It’s the second largest DCIO firm with $420 billionmanaged globally—the firm does not have a record-keeping arm.

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To date, SSgA has been able to grow in the TDF market byleveraging its internal management core competency with the largertrend of lower cost, passively managed investment options.

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According to Morningstar, SSgA’s asset weighted average expenseratio for the State Street Target Retirement series was 13 basispoints in 2016, down from 19 basis points the previous year.

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That aggressive price point put the firm’s line among the leastexpensive: Vanguard’s passive series held an average expense rationof 13 basis points; Fidelity offers a passive series at an averageof 12 points; and Charles Schwab rolled out a new index series lastyear at only 8 basis points.

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SSgA’s large-cap equity index fund, built into its TDF series,cost investors only 3 basis points, according to Morningstar.Schwab’s large-cap fund is as cheap. But other managers' passivelarge cap funds are not. Despite what Morningstar calls “nearidentical objectives,” some managers charge as much as 35 basispoints for indexed large cap underlying funds.

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Shifting the focus to plan advisor specialists

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In 2016, State Street saw nearly $1 billion flow into itstarget-date series. Throughout all of its investment products, thefirm saw $2.6 billion of inflows. That means TDFs accounted for 38percent of SSgA’s new assets.

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Overall, the firm’s share of the TDF market is slim—only 0.1percent, compared to Vanguard, Fidelity, and T.Rowe Price, whichtogether account for 70 percent of the market.

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But few can claim the explosive gains SSgA has captured of late.The $1 billion inflows in 2016 represented a 425 percent organicgrowth rate. Only Dimensional Fund Advisors grew at a fasterclip—DFA saw a 1,520 percent increase in organic growth.

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State Street’s Porteous says the firm is deploying a new,aggressive distribution strategy that is keying on plan advisorspecialists to keep the momentum going.

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“When we first launched our series, we went the traditional way,going directly to plan sponsors. We had some great success withthat. But now we want to deliver through advisors in theintermediary market,” said Porteous.

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In tapping what he says are the 2,400 plan advisor specialiststhroughout the country, Porteous says he thinks the firm can beginto better compete in what he calls the “smid” plan space—small tomid-sized plans.

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Plans with $250 million in assets and less account for $2trillion in total plan assets. Plan advisor specialists service $1trillion of that, says Porteous.

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“The trend of passive investing is moving to the small andmidsized plan market,” said Porteous. “Historically, 85 percent ofassets in the ‘smid’ space have been in actively managed TDFs. Inlarger plans, the split has been closer to 50-50.”

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Smaller plans, whose sponsors are fiduciaries and exposed to thesame liability as large plan sponsors, have become increasinglyaware of fees on the investments they offer workers, saysPorteous.

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“We think it’s healthy to have both passive and activestrategies,” said Porteous. “But smaller sponsors are insisting ongreater levels of transparency.”

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TDF 2.0

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Powerful as TDFs have been in revolutionizing how 401(k)participants save for retirement, Porteous and other definedcontribution experts think competitive forces are pushingevolution.

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Such predictions have been made for years. Like a slow-turningaircraft carrier, the DC market has not quite yet set its newdirection. When it does, Porteous expects the change will beconsiderable.

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“TDFs have proven to be a fantastic accumulation tool forsavers. But they don’t provide a drawdown strategy in retirement.Incorporating a decumulation tool will be the next evolution forthe market,” said Porteous.

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The question is when. Porteous says SSgA has a strategy in placeto build decumulation strategies, like annuitizing portions ofsavings, in place, but he would not elaborate on specifics orcommit to a rollout time line.

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“To do it the right way is difficult,” he said. “You could justdefault everyone into an immediate annuity. But when you are tryingto account for lower costs while guaranteeing income, and includethe portability of assets when savers change jobs, all the whilegiving sponsors the regulatory transparency they need to offer newincome options—that’s a tough solution to get to.”

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Ultimately, the role of regulators will be critical. “If you aregoing to include an income option in TDFs, they will need to fitinto the QDIA space to indemnify plan sponsors,” said Porteous.

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Mass customization

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Another evolution in TDFs is in the offing, thinks Porteous.

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So-called mass customization would leverage financial technologyto create a hybrid of traditional TDFs and managed accounts.

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The knock on traditional TDFs is that they rely on limitedinput—age—to set a savings strategy.

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Managed accounts of course go far beyond that and incorporate awide data set on individual plan participants, and set andrebalance an investment strategy customized to risk tolerancelevels. But they are expensive, and require a level of participantengagement that many say have prevented managed accounts fromgrowing as a QDIA.

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A mass customized TDF would account for information onparticipants’ total net worth, the state they live in, theirmarried status, and spouses’ income, along with risk tolerancelevels, to create a more individualized glide path.

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Porteous says there is buzz around the concept amongrecordkeepers, asset managers and plan sponsors. He expects to seemovement in the next five years.

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But a mass customized TDF is likely to face the same obstaclesthat have slowed adoption of managed accounts.

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“Participants would have to be an active part of this—they’dhave to log into their accounts and provide all of this data.Today, that doesn’t happen all too often,” he said.

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Then there is question of price. Any degree of advancedcustomization, even if done on a mass level, will come at a cost.The question is whether participants would be willing to pay forit.

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“If they see an off-the-shelf TDF option, and then look at amass customization option that costs more, participants will lookat that and ask if it is worth it,” he added.

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Nick Thornton

Nick Thornton is a financial writer covering retirement and health care issues for BenefitsPRO and ALM Media. He greatly enjoys learning from the vast minds in the legal, academic, advisory and money management communities when covering the retirement space. He's also written on international marketing trends, financial institution risk management, defense and energy issues, the restaurant industry in New York City, surfing, cigars, rum, travel, and fishing. When not writing, he's pushing into some land or water.