DC Beats Target-Date and DB Returns in 2013

(March 14, 2014) — US defined contribution (DC) fund returns beat their target-date (TDF) peers and defined benefit (DB) pensions in 2013 but are falling out of favour with investors, research has shown.

Consulting firm Callan showed its Total DC Index rose 20.15% across the calendar year, just outshining 2035 TDFs, which produced 19.94%; while the average corporate DB fund rose 12.56% gross of fees.

“DC plans tend to have much less exposure to longer-term fixed income than DB plans, which accounts for much of the difference in performance,” Callan’s report said. “However, DB plans’ greater diversification also tended to work against them in 2013. While the typical corporate DB plan has nearly 2.5% in hedge funds and another 4% in other alternatives, the typical DC plan has just a tiny fraction of a percent of such exposure. With domestic equities bringing in such blockbuster performance in 2013, it was difficult for alternatives to compete.”

Short-term performance is no guide to the future, but the one year results have narrowed the annualised gap between DB and DC from 1.8% between 2006 and 2012, to just under half a percentage point, Callan said.

Similarly, short-term performance has been no indicator of favour either. Nearly 80 cents of every dollar that moved within DC plans in the last quarter of the year was headed to TDFs, Callan said. Across 2013 as a whole, the figure moving to these vehicles was 70 cents of each dollar.

“TDFs took another step forward during the fourth quarter to becoming the single-largest holding in the typical DC plan, accounting for more than one-fifth of total assets (21.1%) within the DC Index,” Callan’s report said. “Only domestic large cap equity allocations are higher, at 23.7%, followed by domestic small/mid cap equities at 11.9%. While TDFs have never experienced a quarter of net outflows since the DC Index’s 2006 inception, domestic large cap equity has seen outflows more than two-thirds of the time—including the fourth quarter.”

The benefit of TDFs has been greatly debated in recent years, with many dissecting and dismissing the theory behind many of the approaches launched by providers.

In November, a paper by Research Affiliates said the objectives of a traditional “glidepath” approach, namely maximising the real value of nest eggs and minimising uncertainty around prospective retirement income, were actually not met.

However, last month European insurance group Legal & General agreed to buy one of the largest US (TDF) providers to further its push into the DC market.