White paper says gap is closing between DC and DB plans.
In the past decade, defined contribution plans have seen returns creep closer to those of their defined benefit brethren, as more DC plans have seen improved asset mixes and better plan designs, with more automatic enrollment and better default investment options, said a white paper from CEM Benchmarking.
The white paper — "Defined Contribution Plans Have Come a Long Way!" — shows that while defined benefit plans have outperformed defined contribution plans since a similar analysis by CEM in 2006, the gap is closing. For the 10 years ended year-end 2016, DB plans returned an annualized net 5.36%, compared with DC plans' annualized net return of 4.89%, for a difference of 47 basis points. The net return difference from 1998 to 2005 was significantly greater, at 180 basis points, the white paper said.
DC plan returns have improved in part thanks to asset mixes that rely far less on holdings in company stock, and stable value and cash. In the 2006 white paper, CEM had cited asset mix as the primary driver of poor DC plan returns.
In 2016, the average asset mix for U.S. DC plans was 38% equities (up from 37% in 1998, when CEM began collecting this data), 26% target-date funds and balanced funds (up from 15%), 15% stable value and cash (down from 18%), 10% company stock (down from 26%), 7% fixed income (up from 3%) and 4% other (up from 1%).
The white paper also said changes in plan design have contributed to improved returns, such as the increase in the use of automatic enrollment. In 2016, 80% of DC plans that are primary retirement plans had automatic enrollment, compared with 62% in 2007; and in 2016, 70% supplemental DC plans automatically enrolled participants, up from 51% in 2007. Also, the emergence of target-date funds as the qualified default investment alternative has contributed to better returns. In 2016, target-date funds served as the QDIA of 84% of U.S. DC plans, compared with 30% of plans in 2007.
Other QDIAs were far less utilized in 2016 when compared with 2007. Only 1% of plans offered guaranteed insurance contracts or stable value/cash as the default option in 2016, compared with 21% in 2007, while 7% offered balanced funds, compared with 25% in 2007. Most notably, 5% of plans had no QDIA in 2016, while 21% of plans in 2007 offered none.
Finally, differences in fees also contributed to improved net returns for DC plans. The white paper said "costs for DB plans have risen primarily because they are increasingly adopting more sophisticated investment strategies," including hedge funds, private equity and venture capital funds. In 2016, combined policy weights for those three asset classes reached 23% for U.S. DB plans, up from 14% in 2007, compared with less than 1% of DC plans directly invested in those asset classes in 2016.
The results cited in the white paper come from 168 U.S. defined benefit plans, representing $3.6 trillion in assets, and 147 U.S. defined contribution plans, representing $1 trillion in assets. All information comes from CEM's U.S. DB plan and DC plan databases.
The white paper is available on CEM Benchmarking's website.
Robert Kozlowski is a reporter at InvestmentNews' sister publication Pensions&Investments.
