Executive summary:
- For plan sponsors, the trend toward de-risking often leads to a simplification of the equity manager lineup in the return-seeking portion of the portfolio. We believe that DB plans moving to streamline their manager lineup should work with a transition manager during the entirety of the process.
- We also think these plans should have their transition manager chosen and under contract well before the implementation process begins.
- The process of transitioning assets is often complex and requires a blend of deep expertise and specialist capabilities. We believe a skilled transition manager is best situated to oversee this process, as they can ensure best practices are followed, unnecessary costs are minimized, and risk is mitigated.
Fueled by high interest rates and strong equity markets, the trend toward de-risking in the defined benefit (DB) space has accelerated in 2024, with several large DB plans continuing to move more money out of equity markets and into fixed income markets. Although the U.S. Federal Reserve has hinted at potential rate cuts later this year, it’s likely that rates will still remain elevated for quite some time, keeping the value of a plan’s liabilities in check.
Amid this backdrop, we believe de-risking can provide several potential advantages for DB plan sponsors, including a reduction in both funded-status volatility and potential future contributions. However, de-risking does not make sense for all plans. Each sponsor should first consider their organization’s goals, circumstances, and preferences to determine if de-risking is the right move. And for those plan sponsors that do decide to jump onboard the de-risking train, we firmly contend it’s vital to have a transition management provider (and perhaps multiple) selected and contracted well before implementation begins.
Why? The de-risking process creates a key issue that is often not revealed until de-risking begins: the reduction in risk assets reduces scale and a plan’s purchasing power with money managers. This often leads to the simplification of the equity manager lineup, reducing the number of managers to keep fees levels low. Let’s dive in to understand why.
Simplification of the manager lineup
A key trend we’ve observed among DB plan sponsors today is a more streamlined approach to the equity manager lineup in the return-seeking portfolio. This is a stark reversal from not too long ago, when these portfolios were typically designed with a complex manager structure. The reason for the complexity was simple: the multi-manager portfolios were built to cover the spectrum of the available security universe. This meant that managers would span from large cap to small cap and from value to growth.
Often, these structures had multiple managers within both value and growth, with each providing differing approaches and, as a result, different coverage areas. For instance, within value, there might have been a relative value manager, a deep value manager, and a defensive value manager—each representing a different flavor of value. Likewise, within growth, there might have been a consistent growth manager and an earnings momentum manager. Portfolios would also use a combination of active and passive management strategies.
The graphic below illustrates this, showing a hypothetical return-seeking portfolio for a DB plan before the simplification trend took hold. A client could have multiple managers within value (dark blue circles), multiple managers within growth (light blue circles), both active and passive core (orange circles), and small cap (red circle). In sum, having eight managers, like in this example, was not uncommon. And that was just for a U.S. equity portfolio. A global equity portfolio might have had even more managers with the inclusion of emerging markets.
Source: Russell Investments. Hypothetical example only.
We’ve even recently seen some plan sponsors take this streamlining approach even further, moving down to a total of two or three managers in the return-seeking portfolio.
The value of using a skilled transition manager for implementation
From our vantage point, a best practice for defined benefit plans is to use a qualified and experienced transition manager to implement this streamlining, managing risk and minimizing costs—rather than attempting to go at it alone and instructing asset managers to liquidate portfolios and deploy the cash to target allocations.
This is because, quite simply, the process of transitioning assets is often highly complex. Factors such as country domiciles, the regulatory environment, currency considerations, and the liquidity associated with the old and new managers must all be considered. For an organization without the right capabilities, the process can lead to inefficiencies, unnecessary trading, tax drag, and loss of market exposure.
For instance, when simplifying a manager lineup, many securities in the current portfolio will overlap with those in the streamlined portfolio. A transition manager ensures these assets are retained during the transition, preventing them from being sold and later repurchased by individual managers working independently. The transition manager oversees these complex moves, ensuring best practices are followed, minimizing unnecessary costs, and mitigating risk. The transition manager also provides clear attribution of the costs of such an undertaking, enabling the plan sponsor to fully understand the total costs and benefits of making these very meaningful changes.
Ultimately, successfully executing a transition event requires a blend of deep expertise and specialist skills.
The bottom line
For defined-benefit plan sponsors, we believe this trend makes one thing unmistakably clear: Systematic changes are coming to your plan. Consider having a transition manager in place before they do.
© Russell Investments Group, LLC. 1995-2024. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an "as is" basis without warranty.
Products and services described on this website are intended for United States residents only. Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general information contained on this website should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional. Persons outside the United States may find more information about products and services available within their jurisdictions by going to Russell Investments' Worldwide site.
Russell Investments is committed to ensuring digital accessibility for people with disabilities. We are continually improving the user experience for everyone, and applying the relevant accessibility standards.
Russell Investments' ownership is composed of a majority stake held by funds managed by TA Associates Management, L.P., with a significant minority stake held by funds managed by Reverence Capital Partners, L.P. Certain of Russell Investments' employees and Hamilton Lane Advisors, LLC also hold minority, non-controlling, ownership stakes.
A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out our podcasts.
© Russell Investments
Read more commentaries by Russell Investments
