Investment Research: To Build or To Buy? | Lord Abbett
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Practice Management

While investment research has always been an important function for retirement plan advisors, the emergence of outsourcing options for investment research has advisors pondering the best solution for their clients.

Read time: 7 minutes

The Changing Defined Contribution Landscape

The retirement plan industry has undergone a transformation in the last few years. Increased regulation, pressure to reduce fees, and a surge in industry consolidation has compelled retirement plan advisors to redefine their value proposition to their clients. The emergence of large and well-resourced aggregators—broker-dealers that have successfully evolved in their technology and support—and an infusion of private equity capital have only accelerated the need for traditional retirement plan advisors to identify and build upon areas of differentiation. Further, large institutions continually looking for ways to diversify their business have targeted retirement plans as a stable source of recurring revenues and have begun to fish downstream.

Current Focus on Participant Communication and Financial Wellness Services

 

Advisors, asked what they believe would be the most important issues for Plan Sponsors going into 2020, responded that financial wellness and advice programs would be on the top of Plan Sponsor’s list of priorities.

 

For many advisors, differentiation extends beyond the traditional “Triple F” strategy of fees, funds, and fiduciary, and focuses on secondary and tertiary programs designed to provide a more well-rounded experience for plan participants. Currently, over 95% of Defined Contribution Plan Sponsors offer some form of advisory services for their participants, based on data from Callan Institute’s 2020 Defined Contribution Trends Survey1. These programs continue to rank as the top focus of communication based on results from the same survey. Retirement plan advisors have shifted their value proposition toward “Financial Wellness” programs that offer a more comprehensive approach to participant education and improved plan outcomes, a priority for Plan Sponsors (see Exhibit 1).  Advisors have also taken additional business diversification measures by offering similar overall wealth management plans, HSA’s, and benefit programs that span every area of financial life, from maintaining proper retirement plan contributions to managing savings and debt outside of their defined contribution plan. The move to provide programs focused on the participant experience has also been an efficient method for advisors to reclaim a portion of their fees, which have been under downward pressure.

 

Exhibit 1. Plan Sponsor Priorities  

Advisors’ focus on participant services designed to improve outcomes has been in line with clients’ priorities.

Source: Retirement Leadership Forum/Wise Rhino Group 2020 SRAF Survey.  Note: Results based on survey taken in 2019 and reported in January 2020.
 

Filling the Gap: Investment Research Within Small, Mid and Large Plan Sponsor Markets

The second of the Triple F’s—funds—has long been de-emphasized by some retirement advisors, not to ignore the importance of investment returns, but in order to focus their practice on financial and benefit management services for their clients. As a result, an industry of third-party fiduciaries that serve as the investment expert and provide fiduciary protection has been created to fill the funds gap in the Triple F strategy. Firms like Mesirow, Wilshire, Morningstar, and Leafhouse Financial have capitalized on this opportunity to provide an outsourced solution. Known as 3(21) and 3(38) adviser programs, they serve the small plan sponsor market and broker-dealer community with retirement-specific investment expertise and levels of fiduciary support at a low cost. According to Callan Institute, of the 89% of Plan Sponsors that engage an investment consultant (the highest percentage in their Defined Contribution Trends Survey history), 60.2% use a 3(21) plan adviser and 21.6% (up from 15.9% in 2019) use either a 3(38) and a 3(21) plan adviser or a 3(38) plan on its own (See Exhibit 2)2

 

Exhibit 2. Plan Sponsors’ Use of Investment Consultants

The majority of Plan Sponsors use an investment consultant as either a 3(21) adviser, a 3(38) adviser or both. 

Source: Callan Institute 2020 Defined Contribution Trends Survey. Note: Results based on survey taken in 2019 and reported in January 2020.

 

At the same time, the more traditional wealth management firms have taken the opportunity created by the rise in 3(21) and 3(38) adviser programs to diversity their business lines and grow their retirement business by leveraging their robust investment research capabilities. Several complex financial institutions have acquired retirement consultants and have begun to prospect down market to capture market share in this increasingly competitive middle market. Regardless of outsourced or not, the demand for an ERISA fiduciary in Defined Contribution plans has been growing.

Outsourced Chief Investment Officers—or OCIOs—have long served the same function in the large Plan Sponsor market, as the 3(38) providers have served in the small and mid-markets. They serve as a third-party manager research expert and add levels of customization and vehicle integration into their process. OCIOs have also served directly to Plan Sponsors to help evaluate their retirement investment strategies for Defined Benefit, Defined Contribution, and more esoteric benefit programs. Their value proposition has long been robust investment research capabilities, deep and experienced manager research teams, and product and technology platforms that are attractive to large Plan Sponsors. As indicated by the growth in OCIO managed assets (see Exhibit 3), we anticipate strong demand from Plan Sponsors to continue to drive the market for these services.

 

Exhibit 3. Growth in OCIO Assets

The growth in OCIO mandates remains strong, driven by continued Plan Sponsor demand.

Source: Pensions & Investments’ Annual Surveys of OCIO Managers3.  Data as of March 31 of that year.

 

The Research Equation – Solving for Investment Research Distribution

As more complex financial institutions start to swim downstream in the Defined Contribution market, many advisors have seen a need to beef up their investment research in order to compete with larger and more well-resourced providers. For many mid-sized RIAs, to hire and build a research platform can be a substantial investment. Many retirement firms view research or “picking the right fund” as such a minimal factor in retirement outcomes that they have hit an inflection point in their business model.  This has led many of them to make a strategic business decision about whether to invest the resources into building out a comprehensive research platform or outsourcing this expense to a third party.

For those that are choosing the former, the need to find additional ways to monetize this research has taken on increasing importance. Finding ways to monetize research can include diversifying their business into more research-focused markets like defined benefit, endowments and foundations, and high-net worth clients or family offices. Many of these firms have made acquisitions of large wealth management practices in order to better serve a cross-functional purpose and better justify the investment. Other firms have created their own 3(38) programs or OCIO model in which they are packaging their research and communication and trying to distribute it to other RIAs, many of which can be competitors.

For the organizations that choose to outsource this function, they do so to maintain focus on their core business. If they are pure retirement specialists that are focused on plan success and participant outcomes, having a robust research team can weigh heavily on their ability to invest in other parts of their practice that may have a more meaningful effect on this purpose. Many have chosen to partner with one, or multiple providers, in order to provide the depth of research that many Plan Sponsors are seeking. For a traditional ERISA 3(38), many of these providers are embedded into the record-keeping platform and thus represent an “easy-button”. With the entrance of the larger financial institutions in this market, numerous retirement specialists are moving towards a more comprehensive relationship with a third-party provider to better synthesize the investment selection element of their value proposition. While in their minds, manager selection is a small component of “what they do”, for many Plan Sponsors, this defines what they do.

A major trend in both the retirement plan and wealth RIAs is affiliation or mergers with larger comprehensive financial institutions or aggregators. Based on data received in the 2020 Retirement Leadership Forum Survey, industry aggregators planned to acquire, on average, three wealth management firms and four retirement advisory firms in 2020, up from 2019 totals of two and three firms, respectively4. Aggregators facilitate the pooling of resources to build solutions, allowing advisory and wealth management firms to invest in research and technology across multiple shingles. In doing so, they are outsourcing a lot of the functions and expenses that they needed to incur in the past.  Consequently, they lose their ability to customize or monetize this function of their firm. For some, this allows them to focus on their core business and not spend time or resources on peripheral support. For the more entrepreneurial business owners, this diminishes their ability to diversify revenues and find alternative forms of distribution.

Dick Darian, Chief Executive at Wise Rhino Group, a firm focused on mergers and acquisitions in the RIA market says, “Most aggregators have grown organically in the 7-9% range, and that trend is increasing based on more of these firms turning to OCIO, managed accounts, participant advice, and wealth advisory.”

Technology Provides Additional Means to Enhance the Plan Sponsor Experience

One critical element of research providers’ value proposition has become their technological capabilities. If research is the small blind, technology is the big blind. Data and information have become more important than ever in the asset management world. Particularly to defined contribution, data is still running the wishbone offense, while the rest of the industry has put a premium on data delivery and analytics. Providing an integrated platform experience for Plan Sponsors has become one of the most important differentiators for research and fiduciary providers. In fact, many fiduciary providers consider themselves as much fintech firms as they are research firms. Their R&D budgets skew much more heavily towards digitizing and delivering their information than they do towards creating it. This again creates a hurdle for firms looking to build their own research function. If they can hire a research provider that delivers a technological data solution and creates content for Plan Sponsors and participants, what is the breakeven point?

The answer to this question relies on the ability to leverage your own research far beyond that of purely Defined Contribution. There is simply not enough ROI for a retirement-centric firm to build out these capabilities if they can outsource it for a fraction of the cost, particularly if they are acquiring ancillary services that help augment their value proposition.

Final Thoughts

What all of this leads to is a growing industry of diversified financial institutions. A melting pot of entrepreneurial financial services firms that are all starting to look like cousins. The era of the “retirement specialist” or the “family office” is starting to become less defined. Depending on where these financial institutions grew up is generally where the industry classifies them today. But if you ask many of these business leaders over a cocktail what their core business is, many will hesitate to define themselves by any one market, rather laying out a narrative that they deliver solutions to a diversified set of clients. Research can be a key factor toward effectively delivering services designed to solve problems for a diverse set of clients, whether it is proprietary or outsourced. 

 

1,2 Callan Institute, 2020 Defined Contribution Trends Survey, 9.

3 Christine Williamson, “OCIO Growth Assisted by Volatile Times”, Pensions & Investments (June 29, 2020).

4 Retirement Leadership Forum, 2020 Retirement Leadership Forum Survey, 14, 17.

 

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

The opinions in the preceding commentary are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

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