The Callan DC Index™ is an equally weighted index tracking the cash flows and performance of over 80 plans, representing more than 800,000 DC participants and over $100 billion in assets. The Index is updated eight to 10 weeks after the end of the quarter and reflects 401(k) plans as well as other types of DC plans.
The Callan DC Index™ ended the year strong, advancing 6.23% in the fourth quarter. This contributed to a very impressive calendar year return for the Index of 20.15%, making 2013 the Index’s best year since the 2009 rebound when it was up 22.22%.
Defined contribution plans outpaced defined benefit plans significantly during both the quarter and the year. DC plans tend to have much less exposure to longer-term fixed income than DB plans, which accounts for much of the difference in performance. However, DB plans’ greater diversification also tended to work against them in 2013. While the typical corporate DB plan has nearly 2.5% in hedge funds and another 4% in other alternatives, the typical DC plan has just a tiny fraction of a percent of such exposure. With domestic equities bringing in such blockbuster performance in 2013, it was difficult for alternatives to compete. By the end of the year, DC plans outperformed DB plans by an average of 7.59%. This, in turn, significantly narrowed the performance advantage that corporate DB plans have demonstrated since the Index’s inception. Between 2006 and 2012, corporate DB plans outperformed DC plans by 1.8% (average, annualized). Through year-end 2013, DB plans’ performance advantage had been squeezed by recent DC strength to less than a percentage point annually.
The trend in target date funds also experienced a bit of a reversal during the year. Normally, target date funds have tended to outperform DC plans in rising markets. However, in 2013, they lagged slightly with the average 2035 target date fund advancing just under 20% for the year.
For the year ended December 31, 2013, DC plan balances soared 22%, driven almost exclusively by market returns. Plan sponsor and participant contributions (net flows) added 1.85% to growth during the year, or less than 10% of the total growth in balances. Over time, plan sponsor and participant contributions have tended to do more of the heavy lifting; accounting for a third of the total growth in balances (2.84% annualized) since the Index’s inception.
Target date funds remained the recipient of the lion’s share of money that flowed in DC plans during the quarter and the year. Nearly 80 cents of every dollar that moved within DC plans headed for target date funds in the fourth quarter, and more than 70 cents of every dollar did so during the year. In contrast, more than half of the asset classes tracked in the DC Index experienced net outflows during the quarter—including two of its best recent performers, company stock and domestic large cap equity. Domestic fixed income and stable value both suffered significant outflows. Overall turnover (i.e., net transfer activity levels within DC plans), was below average for the quarter and for the year (0.64% and 2.09%, respectively).
Target date funds took another step forward during the fourth quarter to becoming the single-largest holding in the typical DC plan, accounting for more than one-fifth of total assets (21.1%) within the DC Index. Only domestic large cap equity allocations are higher, at 23.7%, followed by domestic small/mid cap equities at 11.9%. While target date funds have never experienced a quarter of net outflows since the DC Index’s 2006 inception, domestic large cap equity has seen outflows more than two-thirds of the time—including the fourth quarter.
Overall, the DC Index’s total equity allocation has increased to over two-thirds (66.8%) of DC plans’ assets. This allocation has been trending slightly upward since the end of 2012; however, it is below the DC Index’s historic high of more than 70%, reached prior to March 2008.