Callan Associates

The Callan DC Index™

Third Quarter 2009

The Callan DC Index™ is an equally weighted index tracking the cash flows and performance of more than 70 plans, representing over 800,000 defined contribution participants and over $50 billion in assets. The DC Index is updated quarterly and reflects 401(k) plans as well as other types of defined contribution plans.

Participants in the Callan DC Index™ underperformed the average comparable (2030) target date fund last quarter. The DC Index is compared to 2030 target date funds because such funds would be the most appropriate target date funds given the age of the typical DC participant. The difference in equity allocation between the DC Index and the typical 2030 target date fund largely explains both recent underperformance and longer-term outperformance. While the typical 2030 target date fund has 83% in equities, the equity allocation of the Callan DC index™ is considerably lower, at 62% as of 9/30/2009. At its nadir, in March of 2009, the equity allocation of the DC Index was 55%. Its lower relative equity allocation throughout the market collapse allowed the DC Index to outperform the average 2030 target date fund, but now is causing it to underperform as the market recovers. The DC index underperformed the average corporate DB plan by nearly 2% annually since the DC Index’s inception at the beginning of 2006. This latter statistic points to the power of institutional, professional money management.

* Performance is gross of fees

Cash Flows

Turnover was above average for the DC Index at 1.13% of assets for the quarter. This is in line with the level of turnover experienced in the third quarter of 2008—but in reaction to very different market conditions. The third quarter flow activity is almost an inversion of what was experienced a year ago. This time last year, poor market conditions resulted in sizeable flows into stable value and money market funds and out of riskier funds. With market conditions greatly improved, riskier funds such as equities and domestic fixed income experienced inflows at the expense of stable value and money market funds. Flows, in fact, were positive for every public diversified equity asset class except domestic large cap equity. This renewed appetite for risk highlights DC participants’ tendency to engage in momentum market timing.

One area of consistent inflows is target date funds. Indeed, flows into target date funds have been positive every quarter since the start of the DC Index. This demonstrates the power of defaulting participants into a fund, as most target date funds are used as plan defaults.

Total Index “turnover” measures the percentage of total invested assets (transfers only, excluding contributions and withdrawals) that moved between asset classes.

Asset Allocation

Target date funds are now offered by 69% of DC plans in the Index. When offered, they account for 18.52% of assets. As a percent of total DC assets, target date funds account for 9.5% according to the Callan DC Index™.

At 62%, participants’ overall allocation to equities is now approaching levels not seen since September 2008. During the market collapse, participants allowed their equity allocations to decline dramatically from as high as 71% at the end of 2007 to as little as 55% at the end of March 2009. As the market recovers, equity allocations are being allowed to increase again. This suggests that participants’ equity allocations tend to be driven less by their actual risk tolerance than by inertia and failure to rebalance.