Thirty years ago I ran the retirement business of Bankers Trust Company. BTCo. was founded in 1903 by J.P. Morgan (the man) and his other banking pals who thought it would be smart to put all their trust business in one institution that he and his pals controlled. BTCo. Grew to become the second largest trust bank in the country. When I was asked to take over the Retirement Services business with it’s 4,000 employees, it was one of the three largest administrators and fiduciaries of defined benefit pension plans and, by virtue of its early role in the employee benefits arena and savings plan business, it was the largest record keeper of the still nascent defined contribution plan business. That was at the start of the 401(k) juggernaut that has since grown to be an $11 trillion investment behemoth. That represents about 28% of all retirement assets in the U.S.. I think of the trend as starting with the promulgation of ERISA (Employee Retirement and Income Security Act) in 1974 and getting its foundation in the 1978 of the Revenue Act, which established section 401(k) of the Internal Revenue Code as well as its kissing cousins in the defined contribution market, the 403(b) and the 457 accounts for non-profit and government employees. The mutual funds business has already discovered the wonders of defined contribution and now represent 65% of the assets. What I recall from those days of running that large DC administration business was spending a lot of time thinking about how we could craft sophisticated new investment products for this growing pool of money. The problem was that between the Department of Labor and the Internal Revenue Service, the arcane and intentionally restrictive rules protecting these retirement funds made the structural aspects of tapping that pool more than challenging.
But as that pool of assets have grown, the prize has only become more appealing and the biggest alternative asset management firms, who are now the biggest purveyors of sophisticated financial products, are dedicating big resources to cracking that code to enter the 401(k) market. On its earnings call this month, KKR, with its $624 billion in assets under management and its brand name private equity image, has announced that it is expecting big growth in those assets coming mostly from 401(k) plans. Their targeted product offering seems to be in none other than the TDF (Target Date Fund) product array. This important sleeve of the defined contribution product array offered to plan participants currently has 86% of participants using some amount of TDFs for their investment program. That translates into almost 40% of the $11.3 trillion of defined contribution assets or $4.5 trillion. As purveyors of private assets (i.e. not publicly traded investments), what KKR is saying is that they expect to be able to introduce their private asset products (both private equity and presumably the fast growing private credit products) into this pool.
I have lately been involved as an expert witness on several cases involving defined contribution plans that use TDFs. Back in my early retirement services days, these things were called lifestyle funds, but they have mostly morphed into these supposedly easier to understand Target Date Funds. What I have learned is that they are investment vehicles that are deeply rooted in many defined contribution plans. By deeply rooted, I mean that they are often established as the plans’ QDIA (Qualified Default Investment Alternative) or the place where unspecified employee contributions are invested under a safe-harbor plan liability provision of ERISA. Additionally, their pervasive use among participants and the relatively large array of vintages (target date years) make them product suites more than just product offerings. How participants use them both to and now through retirement is all important to the American retirement income security landscape. They use both active and passive funds, sometimes as a blend and sometimes as a preference for one or the other as elements of their strategy. The asset management industry long ago realized that asset allocation rather than individual asset or fund selection was the biggest attribution towards performance. These product suites are run by managers who are not just stock or bond pickers and not even just fund of funds pickers, or even asset allocators, they are retirement financial strategy managers, required to consider everything from investment glidepath, longevity trends to mega-market trends in public and private markets.
One of the problems with TDFs is that performance monitoring is made much more difficult by virtue of this multi-faceted nature of the beast. If an individual stock or bond is being monitored, its a fairly straightforward investment to track and judge whether it should be retained or divested. It is marginally harder to do this with a fund or a specific fund manager because there are especially more qualitative and quantitative factors to consider, but it is fairly easy to do nonetheless. But assessing the absolute and relative performance of a TDF is a far more complex issue. Plan fiduciaries and participants have to consider a broader array of factors and almost another layer of evaluation. In the same way that adding qualitative factors on top of quantitative factors makes an evaluation harder, adding less easily defined criteria and dimensions that must encompass the needs of a broad and diverse array of participants across a broad and diverse array of underlying assets and asset buckets on the shifting sands of longevity and social dynamics impacting retirement income requires a whole new level of monitoring. Plan fiduciaries are already challenged to update their investment policy statements to incorporate the state of the art tracking and evaluation mechanisms to do this. Add in the opaque and sometimes contingent claim nature of private market investments on top of that and you have one helluva task ahead of you.
KKR is not alone in wanting to and working towards addressing what they see as this attractive market opportunity. In addition to other large alternative manager platforms (including the traditional investment banking firms that already offer asset management services), those that are straddling the risk divide of investment risk and actuarial risk are also focused on this prize. The most notable contender in that realm is Apollo with its heavy involvement in the insurance sector. They see an entire world of new product offerings to help retirees solve their most pressing investment and benefit needs.
The democratization of retirement that has defined the past generation of shifting from the defined benefit to the defined contribution rubric for retirement planning has left many features that participants need and want in the ashes. Never let it be said that financial services firms can’t smell a new opportunity when such a gap opens up. The interesting aspect of this to watch closely is how the regulatory framework will address this flurry of activity. We stand at the cusp of a vast divide in regulatory philosophy as epitomized by the new fiduciary rule which the liberal democratic forces want established and the conservative small government forces want to cast aside. That proposed rule addresses some, but perhaps not all of the risks of these new private market and insurance product offerings into the defined contribution vault. While the big picture path may get decided by the recent election, the subtlety of the risks will take much longer to suss out and there are likely to be multiple liability paths created that will need to be adjudicated in the not so distant future as Boomers reach their retirement cycle peak and recognize their shortfalls and look for resolution and relief.