Custom strategies will hold 22% of 401(k) target-date fund assets by 2016, or $218 billion, according to research from Cerulli Associates. That will be a nearly four-fold increase from the 2011 asset level of $46.4 billion.

“The use of custom target-date funds provides access for DCIO [deputy chief information officer] asset managers to the growing pool of DC assets,” said Kevin Chisholm, senior analyst and lead author of Cerulli’s study entitled, “The State of Large and Mega Defined Contribution Plans: Investment Innovation and the Plan Sponsor Perspective.”

He added that “these products also allow new asset managers to participate in this market, outside of the few that have dominated the space since the Pension Protection Act of 2006 blessed these funds as Qualified Default Investment Alternatives.”

Cerulli’s research also noted that custom target-date funds open the door for alternatives in DC plans as alternative asset classes have long been missing from these plans' investment lineups.

“Additional asset classes are often only added to DC plans long after the rest of the industry begins to consider asset classes as traditional,” continued Chisholm. “For example, inflation-protected bond funds are only now being added to plans investment lineups. We expect that plan lineups will include a mix of investment vehicles with strategy trumping vehicle in the decision-making process.”

Custom target-date funds may choose alternative structures (such as collective trust funds) over mutual funds, but mutual funds are expected to remain the product of choice for the majority of choices in plan investment lineups.

According to the research, the investment vehicle is a secondary consideration, and if savings from a collective trust is not significant, then plan sponsors are likely to continue to use mutual funds, especially in the large market ($250 million to $1 billion in plan assets) where mutual fund use as a percentage of assets is higher than in the mega market (more than $1 billion).

Cerulli estimates that there is $139.5 billion in target-date assets in the mega market segment.

Moreover, according to the research, the move to custom target-date funds, which create a “glidepath” specifically for a company’s employee population and use best-in-class investment managers for each respective sleeve of the target-date strategy, would open the door for all asset managers to this growing stream of consistent flows.

Most survey results that have been published suggest that the overall percentage of plan sponsors that have already implemented a custom target-date strategy to be about 10%. However, there is bifurcation in the market, in which plans with more than $1 billion in assets are more likely to use custom target-date strategies than plans with less.

Tommy Fernandez writes for Money Management Executive, a SourceMedia publication.

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