Mutual fund manufacturers are always in search of sticky assets. Lately they have been hard to find, as record volatility unleashes substantial reductions.
That doesn’t mean new money isn’t coming in. But fear keeps a lot of it on the sidelines. Unless you’re working on autopilot.
That’s what employer-sponsored plans do: Group RRSPs, defined contribution plans and deferred or employee profit-sharing plans—what, in the jargon of the pension regulators are called capital accumulation plans (CAPs).
The CAP universe is not a well-known one—nor an easy one to navigate—for most advisors. It is largely dominated by insurance companies, rather than mutual fund manufacturers. Because of the lifecos’ economies of scale and broad experience in providing group benefits, they control 80% of the market.
Moreover, the absence of a U.S.-style safe-harbour provision has kept Canadian CAP providers from moving beyond education of plan members to advice. The U.S. Employee Retirement Income Security Act allows for some version of advice with liability, hence the notion of a safe-harbour. These are still treacherous waters in Canada.
And yet, those are relatively sticky assets. As of June 2008, CAP assets totaled $94 billion, according to research by Investor Economics, a Toronto consultancy. And these assets are growing at a faster rate than those of traditional retail mutual funds.
That’s a juicy market for asset managers. Some, of course, have targeted this opportunity, including Franklin Templeton, Fidelity, Russell Investments and Invesco Trimark. However, as back-office service providers, they have had little success, and indeed, Fidelity has exited the market.
The CAP marketplace has seen a considerable evolution. For one thing, employers are growing less and less likely to sponsor the kind of defined benefit plans that were emblematic of the post-war era of manufacturing on a grand scale, with tens of thousands of employees. As companies have downsized, with one worker supporting two or three retirees, the liabilities have become more onerous to fund. The travails of Detroit’s Big Three are only the latest iteration in a process that has encompassed steel makers and airlines, among other industries.
Moreover, the means to fund these plans have proven volatile, as plan sponsors discover that the long-term equity risk premium over plain vanilla government bonds can involve some fairly painful short-term liability-asset mismatches, exacerbated by regulations that, on the one hand, prevent pension plans from banking seven years of feast to cover seven years of famine, and on the other, don’t provide clear guidance on who owns the plan surplus—if there is one—the employer or the employees. As a result, there are structural factors that favour a shift to CAP plans in many industries outside the public sector, and, in fact, there is a strong incentive for entrepreneurial companies to attract and keep skilled employees through generous CAP plans, including employee profit-sharing.
This is the new universe; yet it has been occupied by veteran investment counsellors who initially advised traditional DB plans: Connor Clark & Lunn, Sceptre and McLean Budden. But over the years, Investor Economics notes, the CAP space has opened up to familiar mutual fund brands, as the lifecos embrace an open architecture.
Still, there is a countervailing tendency, as the lifecos seek vertical integration: integrated manufacturing, packaging and distribution, whether through buying asset managers, offering more money-management services or stepping up efforts to gain brand-name recognition.
Investor Economics points to Manulife’s promotion of its Income Plus product as an example of the latter.
Still, in the group space, the margins are tight. Typically a sub-advisor gets 30 to 40 basis points for asset management, while the insurer adds 20 to 30 basis points for its services. Mutual fund manufacturers participating in a CAP plan might see 100 to 150 basis points for an all-in plan. On the other hand, I- and O-class shares sold to high-net-worth and institutional clients are in the sweet spot; they sport lower MERs since there is little in the way of marketing or client support required.
However, plan sponsors are looking to reduce the number of fund options that are on the shelves. At the same time, the share of portfolio solutions or funds of funds is increasing, at the expense of individual pooled or mutual funds. Often the portfolio solutions take the form of target-date funds, which are increasingly seen as a default option for plan members, obviating the necessity of navigating through dozens of potential investments.
While the CAP universe is expanding steadily, it poses challenges: assets come in small bits and investment horizons may be shorter as assets are drawn down to fund retirement. Beyond that, competition means margins are tight.
 | Filed by Scot Blythe, Advisor.ca, Scot.Blythe@advisor.rogers.com |