Considerations when a Merger Affects DC Plan Investments

The obvious: Mergers create something new out of the original corporations or funds. But there are many other effects that are less than obvious — and among them is the impact on the investments into which those entities’ associated defined contribution plans have been placed and how the funds in those plans will be invested.

In a recent blog post, Cammack Retirement’s Tom Ferrara cites merger and acquisition (M&A) activity of firms and individual funds as an additional force that has a great impact and discusses matters to consider when a merger has taken place and has affected a DC plan’s investments.

Ferrara identifies a variety of trends he considers especially relevant to M&A of firms and funds:

• pursuing economies of scale;

• responding to asset outflows and fee pressure;

• building or buying products in new asset classes or segments;

• the growth of target date funds (TDFs);

• lawsuits related to the Department of Labor’s fiduciary rule and DC plans; and

• monetization of assets during a bull market.

“The anticipated results of these trends will reshape the industry,” Ferrara argues, and thinks that their impacts could include fewer:

• investment management firms;

• independent, stand-alone investment managers and focused strategies; and

• distinct funds available for investment.

He also thinks those trends could result in higher asset allocations to TDFs, passive investments and other low-fee vehicles.
Ferrara argues that this could have beneficial effects. “While having fewer choices is sometimes characterized as a negative for consumers, a reduction in the number of firms and strategies could actually be beneficial for investors,” he says, and explains his position by attributing that to:

• improved fee transparency;

• reduced trading costs;

• upgraded technology; and

• potential enhancements in risk-appropriate allocations through the growing utilization of TDFs.

But the most important effect for DC investors, Ferrara says, will be streamlining investment lineups.
Ferrara writes that “investors should expect a continuation of the M&A activity as managers adapt to the increasing impact of defined benefit plan closures, target date funds, ETFs, and flows to passive strategies among other recent trends” and that this will benefit DC plans and participants. He does note, however, that there also could be detrimental effects:

• merged assets may be combined into a fund with a different strategy;

• tax consequences as the fund manager realigns assets; and

• the possibility of higher expense ratios in the receiving fund.

Ferrara argues that investors “would be well-served” to consider whether investment strategy will change, what the effect will be on fees and what the tax consequences could be when a merger takes place. “If an investor is comfortable with the answers to those three questions,” says Ferrara,” then the transaction may make sense,” but if they are not, those considerations “should form the basis for further due diligence and evaluation of the portfolio.”