TDFs Outperformed Typical DC Investor Since 2006
Sep 27, 2017
The Callan DC Index returned “a healthy 3.06%” during the second quarter, reflecting strong equity market performance among defined contribution (DC) plan investors.
“Combined with impressive first-quarter gains, the Index is now up 7.87% year-to-date—its strongest first-half performance since its 2006 inception,” Callan reports. This strong performance is appreciably higher than predictions made widely by firms in the last year or two, as return forecasts for the next decade were trimmed to the low- to mid-single digits.
Somewhat troubling, the index actually trailed the typical age 45 target-date fund (TDF), which gained 3.65% in the second quarter and 9.42% in the first half of the year.
“These are the TDFs that would be selected by participants age 45 and retiring at age 65—or the typical DC participant,” Callan notes. For context, the firm reports TDFs have benefited from higher exposures to non-U.S. equity and emerging markets relative to real investors; both investing categories are up sharply year to date.
“The typical DC participant has less than 1% in emerging market equity exposure and less than 6% in non-U.S. equity exposure,” Callan says. “In comparison, the typical Age 45 TDF has 5.2% in emerging markets and 20.1% in non-U.S. equity. Exposure to stocks is greater in TDFs as well, with the equity allocation of the typical Age 45 TDF coming in at 76%, compared to the typical DC participant’s 70%.”
Callan researchers explain the average TDF has outperformed DC plan investors by 76 basis points annually since they first started measuring in 2006. As a rule of thumb, due to their overall heavier equity exposure, “TDFs have tended to outperform in strong markets, and underperform in weak markets.”
Also important to note about the performance history of the index, the last quarter’s increase was almost entirely due to return growth (3.06%) rather than inflows (plan sponsor and participant contributions), which contributed just 0.13%. “Since inception, the average plan balance has grown by an impressive 7.96% on an annualized basis,” Callan says, “and nearly three-fourths of this (5.88%) is due to market performance; the rest (2.08%) is driven by inflows.”
Callan further observes how the proportion of net flows into non-U.S. equities during the quarter was the highest since late 2007. “This is not surprising as DC investors tend to chase performance,” researchers suggest. “Money primarily flowed out of stable value, U.S. small/mid cap equity, and company stock. As usual, TDFs attracted the lion’s share of net flows, with 69 cents of every dollar of flows moving into these funds. Over the Index’s history, an average of more than 50% of net flows have been directed to TDFs. These consistent inflows have solidified TDFs as the largest holding in the typical DC plan.”
The quarterly analysis also states that investor turnover reached only about two-thirds of its normal rate during the quarter under consideration, while the DC index’s overall equity allocation edged up from last quarter to nearly 70%. This is slightly above the Index’s historical average of 67%.