A] Prelude*
* For more general and detailed information about U.S. retirement plans, feel free to visit our dedicated webpages: https://expatpensionholland.nl/usa-expat-pensions
The central question on which we now focus is the following: U.S. manager concentration dominates corporate retirement plans. Can smaller managers compete?
David O’Meara, senior director and head of Defined Contribution (DC) investment strategy at WTW said that the scale of the largest managers has given them significant advantages in multiple areas.
“There is a downward pressure on fees,” O’Meara said. “That includes the long-term trend of an increasing use of individual passive investment options and target-date funds, which the largest managers have always dominated in the market, as well as active strategies that have more operational scale and can reduce fees appropriately.”
O’Meara said that the growing share the largest managers have in the DC plan market can also be attributed to the demand for information from retirement plan sponsors. “(That comes) through their RFPs and collecting more information, in particular ESG or sustainability metrics,” said O’Meara. “The larger firms can have greater resources to respond to that and provide that type of information.”
Dave Keil, partner at Aon Investments USA, said continued derisking by corporate DB plans has resulted in fewer managers overseeing those assets. “If you had 70% in equities, you’re likely to use a lot of managers,” said Keil. “If you now have 70% in investment-grade fixed income, you can get great diversification with just three or four managers.” Those three or four managers are more likely to be the larger managers, he added.
B] Differentiation
O’Meara said the intermediate- and smaller-sized managers need to differentiate themselves from the larger managers. He said he tends to see more of an alignment of interests in smaller managers. “(That includes) things like greater ownership of the firm within the investment team, or the greater longevity of the portfolio managers,” said O’Meara.
One of the trends leading to consolidation among managers is merger and acquisition activity among larger managers, who are buying up smaller firms in order to package their offerings in a suite of solutions. “(Middle-market) managers do need to find how they’re going to participate in that trend,” said O’Meara. “So are they going to partner with other asset managers or are they going to partner with an OCIO solution?”
The growth of the OCIO market may provide smaller managers an outlet for opportunities, he said. Investment consulting firm Mercer is one such OCIO provider. As of Dec. 31, Mercer reported $310.8 billion in assets managed for non-government retirement plans, up 16.3% from the previous year. That AUM will only grow this year after the firm closed its acquisition of Vanguard Group’s OCIO business in March.
Jay Love, U.S. chief investment strategist at Mercer, said in an interview, “You’re going to find probably more opportunity for alpha with midsize managers.” “Once they get too big, obviously it’s tough to keep generating alpha,” Love said. “There are exceptions, of course, some of which I’m sure have been reported, but they’re definitely few and far between.”
C] Alpha more consistent
The ability for the middle-market managers to generate alpha more consistently than the largest managers is their greatest selling point, said Love. He said Mercer’s healthcare clients and wealth management clients and their foundation and endowment clients are showing particularly strong interest in finding those types of active managers.
The disparity in AUM growth in 2023 is far smaller among managers of foundation and endowment clients, according to P&I’s survey. As of Dec. 31, the 25 managers with the highest reported assets managed for foundations and endowments reported $700.2 billion in AUM, up 9.1% from the previous year, while the remaining 287 managers reported $307.6 billion, up 8.7% from the previous year.
Investors’ level of interest in the kind of active risk provided by middle-market managers has picked up a little bit, said Love. “We’re seeing more interest in what we call values-aligned investing,” said Love, “finding somebody who will invest with a philosophy outside of pure returns that aligns with the institution’s core values.”
“The growing interest in the U.S. in sustainability and thinking about things in that way doesn’t necessarily lend itself to driving toward midsize managers, but midsize managers perhaps have more capability to adapt to what clients are looking for,” said Love.