The following topics are covered in this month’s Research Newsletter from the BeManaged Research Department.
- Late Rally Saves Second Quarter Statements
- Fiduciary and Suitability Standards: Copybook Headings for Investors
conflicts of interest
401(k) Fiduciary Best Practices Available on Your iPod
I am an iPod junkie. I admit it. However, I did not take advantage of the vast library of information available in the Podcast section of iTunes until just lately.
I was recently made aware of Don Davidson‘s new “Talk 401k” podcast, and decided to take a listen. After hearing his first podcast with Tom Kmak of Fiduciary Benchmarks, I was sold. The 20 minute interview was concise and informative. I don’t know about you, but when I can listen in and take a break from having to read everything on 401(k) fiduciary best practices, it’s quite nice. I would highly recommend subscribing and listening in when you have a chance.
4 Ways the New 408(b)2 Disclosure Regulations Will Benefit Plan Sponsors
The new 408(b)2 disclosure regs have been long awaited, and present a great opportunity for companies to better understand and benchmark the fees associated with their 401(k) provider. Additionally, it will be require 401(k) service providers to better articulate value in light of the fees they charge. ERISA requires plan fiduciaries to review the fee structure of, and I paraphrase, “reasonable fees for reasonable service.” What is reasonable? That is for plan fiduciaries to determine via the value proposition delivered by 401(k) service providers, which includes recordkeepers, TPAs, custodians, advisors and yes, participant advice providers.
While the impact of this disclosure does not directly impact us as a 401(k) participant advice provider since we have been transparent and conflict-free from the start, there are a lot of benefits for the companies and employees we serve. Here are a few:
- Service Providers Must Disclose Whether They are Fiduciaries – There is so much confusion over this issue, it is great to see the regulations require this so to clarify for plan sponsors who is and who is not acting as a fiduciary. Most plan fiduciaries have been confused by this over the proliferation of the terms used by service providers such as fiduciary, co-fiduciary, fiduciary warrant and especially advice, which automatically makes someone a fiduciary. Per InvestmentNews.com:
“Along with requiring bundled service providers to break out costs of their record-keeping services, the new regulation also requires providers to disclose whether they are acting as fiduciaries to plans.”
- Disclosure Simplifies Plan Reviews and Benchmarking – Understanding value will be much easier if there is some standardization and definition of what services are to be included under each term. Making an apples to apples comparison is critical for making a large decision on a large purchase, such as a 401(k) service provider.
- Independence and Conflicts to be Better Articulated – Understanding the inherent conflicts of interest with various service providers. Per InvestmentNews.com,
“Under the rule, consultants — and many plan service providers — will be required to reveal to DB and DC plan sponsors hitherto undisclosed compensation they are receiving, including any revenue sharing or finder’s fees.”
- Transparency Improves Clarity – It is obvious, but understanding what plans are paying for various providers has been extremely difficult to understand for many companies. Including us. We do not do plan-level consulting work, but when we are working on a plan that has a fiduciary plan consultant, the quality of the plan has a distinctly different flavor than the plans that do not. Service and value are the at the crux of the conversation, which ultimately resonate in greater outcomes for participants. Per InvestmentNews.com,
Alison Borland, retirement strategy leader at unbundled provider Hewitt Associates, Lincolnshire, Ill., said: “The regulations will put different types of service providers, including bundled and unbundled providers, on a level playing field.”
“Ultimately that means better transparency, more negotiating power and lower total costs for plan sponsors and plan participants.”
Cheaper is not always better. Receiving the best value for a reasonable cost is all this disclosure regulation is aiming at in our humble opinion, which is great for plan fiduciaries and their participants, which includes themselves.
BeManaged Cited in Congressional Testimony Regarding 401(k) Advice
Our friend Matthew Hutcheson, Independent Fiduciary, recently conducted testimony with the Congressional Ways and Means Committee. The goal of the testimony was to discuss fiduciary best practices as well as avoiding the potential conflicts of interest inherent to the broker dealer model in the 401(k) world. When the topic of 401(k) advice was discussed, information we provided him was cited. Our information spoke to the potential conflicts of interest that could have existed under the original January ’09 proposal, which has since been replaced by a conflict-free proposal by the DoL in February of ’10. The following is the testimony and the reference to us:
Independent Fiduciary Adviser, Chad Griffeth, AIF®, makes the following observation:
If the provider of the advice is being paid by the mutual funds in any way, trust is damaged dramatically. The reality of the situation is that the advice provider must earn participants’ and management’s respect, and the story of true independence, fiduciary prudence, and thus acting in the sole interest of the participant’s best interest is critical to the success of the advice provider, and thus the participants. If participants do not trust the source of the advice and account management, they will not use it, even though they need it. Thus, participants will likely not experience the success they need for a dignified retirement.[6]
DoL to Issue New 401(k) Advice Rule Potentially by the Fall
The comment period for the DoL’s new 401(k) advice period ended on March 5th, and the 70 response letters will be under consideration by the Employee Benefits Security Administration. Financial-Planning.com reported that the Department could have the rule on advice finalized as soon as this fall. Though it might end up being four years since the PPA was passed before this rule is finalized, it should be worth the wait for 401(k) investors due to its conflict-free, fiduciary approach.
The article in Financial Planning had some interesting tidbits on the advice rule, as it has been a highly contentious issue, which is reflective of the time that has passed without final clarification.
(Assistant Secretary of Labor Phyllis) Borzi noted that investment advice in defined contribution plans has been EBSA’s “most controversial regulation, having already been debated by two or three Congresses.”
Advice in 401(k) plans has proven so thorny, Borzi noted, that it was the final item in the Pension Protection Act, “with the debate focused on who should be able to provide investment advice—and that it be reliable, simple, understandable and relevant advice.”
Effectively, the PPA of 2006 changed ERISA, and since then, the “dispute has been as to the nature of the safeguards to provide advice that is independent of the plan,” Borzi said.
“This is a very controversial regulation. It was published on the day the new administration took office, and we took a fresh look. The comment period closed two, three days ago,” Borzi said on Friday. “We have received 70 comment letters and have promised Congress we will be faithful to the intent of the original statute.”
Read Article at Financial-Planning.com
The Temptation (and Danger) of Past Investment Performance – NYTimes Bucks Blog
It’s understandable. We look to invest in something different in our 401(k), and what is the most accessible bogey to judge the funds in your plan? Past performance. They tug at the foundation of human nature, greed and fear. Our friend Carl Richards wrote an excellent piece in the NYTimes.com Bucks Blog on this topic:
Whenever a mutual fund advertises performance, the Securities and Exchange Commission requires that it includes the disclaimer that “past performance does not guarantee future results.”
A new study by researchers at Arizona State University and Wake Forest Law School suggests that this warning is not enough. They recommend something a bit stronger: “Do not expect the fund’s quoted past performance to continue in the future. Studies show that mutual funds that have outperformed their peers in the past generally do not outperform them in the future. Strong past performance is often a matter of chance.”
Despite the warning from the S.E.C. and pretty conclusive evidence that past performance has very little predictive value, most of us still use performance as the predominant factor in choosing our investments.
This is one of those times in investing where our experience in almost every other area of life works against. If you’re going to hire contractors to remodel your house, one of the first things you do is look at other houses they have done. It seems reasonable to expect that the work they do on your house will be at least as good, if not better.
When it comes to mutual funds, however, the past has almost no predictive value. People have spent years looking for a way to identify mutual funds that will do well going forward. They have looked at almost every factor you can think of: education, experience, hair color and, of course, past performance.
The only factor anyone has found with any predictive value was the internal costs of the fund. The higher the costs, the worse the performance. This is a case where you often get what you do not pay for.
Despite all the evidence to the contrary, we still scour the annual lists of “Ten Hot Funds to Own Now,” which are often based on past performance, looking for a place to put our life savings. We still look in the rear-view mirror. Think about the last time you made an investment decision. Did you look to the past for some prediction of the future? After all, how much sense would it make to invest in a fund that had performed poorly?
But finding the next Peter Lynch is an almost impossible task. Focus instead on finding a low-cost investment that you can stick with over the long haul.
Read the Article at NYTimes.com
401(k) Paternalism – Employers Take More Active Role in Employees’ 401(k) Decisions
April 2010 Issue
This month’s CFO magazine featured an interesting article regarding the change taking place in how employers’ are taking a more paternalistic approach to their employees’ decisions with their 401(k) accounts. Some of the issues that have made paternalism more necessary (not that it’s new news) are as follows:
Employers have long struggled to educate employees about how to actively manage their accounts for maximum gains.
Fidelity reports that among the 11 million 401(k) plan participants in the plans it administrates, only 6.1% made any kind of asset exchange in the hairy last quarter of 2008, up a mere percentage point from the previous quarter, and only 11.3% took any action in all of 2009.
For those of you that are thinking, “Well, that’s better than a higher percentage of people jumping in and out,” you have to consider this also means there was little to no rebalancing taking place late last year after the market’s rebound.
While that inertia likely saved many people who otherwise would have made bad moves, such as selling at the bottom of the market and buying back in as it climbed, it is hardly what most would consider a wise investment strategy.
Unfortunately, we have run into fear and greed oriented investing (seeing a lot of greed right now) numerous times, regardless of the investor’s perceived level of investment sophistication. That being said, what are they doing about it?
Investment Advice:
Fifty-one percent of employers now offer online investment guidance, 39% provide online advice, and 30% offer phone access to advisory services, according to a recent Hewitt survey. Another 34% plan to add some form of advice this year. (At most companies, the retirement plan or the company itself will pay for a third party to provide this advice, in order to avoid the legal burdens that befall company executives who give it.)
While this sort of help sounds good in theory, there are several obstacles. For one, the perpetual debate about what kinds of advice can be offered, and by whom, has yet to be resolved. Pending regulations at the Department of Labor are likely to redefine what is and isn’t acceptable, and a bill in the House of Representatives (HR 2989) also seeks to put new boundaries around it. “Until the Department of Labor advice regulations are finalized — there’s some justifiable angst about what is conflicted advice and what is not” — many employers are sitting tight, says Lori Lucas, defined contribution practice leader at Callan Associates, an investment consulting firm.
Managed Accounts:
Some 26% of employers now offer this option. Among them is Allergan, a $4.4 billion maker of pharmaceutical products. “A lot of people have come to me over the years and said, ‘I’d rather have someone do this for me,’” says Gary Prem, assistant treasurer at the company. Several years ago he enlisted Financial Engines (which offers both advice and management options) to do just that.
In our opinion, managed accounts are simply a more efficient delivery of investment advice, and should be held to the same DoL conflict-free, fiduciary standard as 401(k) advice (more to come on this). However, for the time being, both services options are becoming much more appealing to paternalistic employers sponsoring 401(k) plans. The level of uncertainty in the stock market, as well as the DoL’s proposed regulations of conflict-free advice, should only continue the advancement of plan sponsors moving forward with providing 401(k) advice/managed accounts to their employees, which is the help they desire.
401(k) Managed Accounts – Simply a Method of Delivering 401(k) Advice
401(k) managed accounts and 401(k) advice are often considered two entirely different things in the retirement plan industry. Apples and oranges? I find this odd, to put it lightly. The ’01 SunAmerica Opinion opened the door for participants to receive advice or account management on a fee for service basis. Specifically, the following is the text from the SunAmerica Opinion, which simply states both investment advice and “discretionary asset allocation” (aka account management/managed accounts) are available:
Under the Program, asset allocation services may be rendered to Plan participants either through the “Discretionary Asset Allocation Service” or the “Recommended Asset Allocation Service” (collectively, Services; singly, Service). Through the Discretionary Asset Allocation Service, a specific Model Asset Allocation Portfolio will be implemented automatically with respect to a participant’s account (Account). Through the Recommended Asset Allocation Service, a specific Model Asset Allocation Portfolio will be recommended to a participant for investment of his or her Account and the participant then may choose to implement the advice, or to disregard the recommendation and invest in a manner that does not conform to the Model Asset Allocation Portfolios. Read More
However, when the Pension Protection Act (PPA) was written in ’06, it spoke only to investment advice. Why the concern? An advice-only solution for 401(k) investors causes a lot of concern for us. Here’s why:
Advice on it’s own simply doesn’t work well.
Unfortunately, it’s true. In our experience, which has been reiterated by numerous advisors, the majority of participants that receive advice will not implement it. This point was reinforced in an article below from CFO.com:
“And even if you do go through the questionnaire, few people actually act on the advice, and even fewer go back and do it again next year.” – Robyn Credico, senior retirement consultant at Towers Watson
Read Full Article
While a person that would expect all people to act rationally would assume 401(k) investors would immediately implement the necessary changes to their portfolio, it simply doesn’t work that way for everyone. When given the choice of “do-it-for-me” or “it’s-your-responsibility-to-implement,” the choice is clearly to delegate the responsibility. For example, we have an employer client that has by far the largest percentage of “advice only” participants of any of our clients, yet they only represents a little over 4% of the total clients using our services.
We look at 401(k) advice as a service that can be delivered in one of two ways, either in a “do-it-for-you” format (managed account) or in a manner which the participant implements the advice themselves (pure advice). When participants and plan sponsors consider this, the following human behavior issues have been key to the discussion:
- Remembering Their Login: If ever there was a study of how many people do not know there 401(k) login, the results wouldn’t be pretty.
- Trading Mechanism: Even sophisticated investors can get tripped up using the 401(k) provider’s online trading mechanism, especially when it comes to redemption fees (we have had advice clients cost themselves hundreds of dollars by not navigating this carefully) as well as remembering to reallocate contributions (if a part of the advice).
- Advice Becomes a To-Do: When a 401(k) investor has considered using independent advice, and given the option between implementing changes themselves or having a research analyst do it for them, we simply ask them how many emails they get in an average day. Why? If our advice is one of the 30-50 emails they receive in a day, then we effectively become a “to-do” on their list. “I’ll get to it this weekend…okay, maybe next weekend…” Unfortunately, time and responsibilities can get in the way of doing some of those things you know you need to, but simply haven’t gotten to yet. It’s just like that coffee table I was going to refinish…two years ago. The ability to delegate this responsibility is refreshing to investors, especially when there is no additional cost for doing so.
- Anchoring to Investments: This is a common issue for investors who are waiting for a specific fund to get back to $X. Just think about those Fidelity Magellan investors waiting to get back to where they were ten years ago…
- Second Guessing of Advice: We have also found that many “advice only” clients will second guess the advice provided them without any analytical or rational justification. As with anything, advice comes down to trust, and some people simply do not trust advice until it has “proven its worth.” It would be synonymous with an avid “car guy” questioning whether a belt should be replaced without using the tools or having it on the hoist to see that it was indeed about to break.
All in all, when you look at the scenario from a 401(k) investor’s perspective, as well as that of a plan sponsor who understands human behavior, a managed account is simply a more effective implementation of advice. Both the employee and employer want to make sure that if such a service is being paid for, the intended benefit (individualized, age, time horizon and risk appropriate asset allocation) is received and experienced. In the little niche world we live in, we do not consider 401(k) advice and managed accounts/account management as two different realms, instead, they are simply the same concept with two different delivery approaches.
Such a realization begs the question, should managed accounts be held to the same conflict-free standard as is 401(k) advice? That will be discussed in the next post.
We welcome your thoughts and comments on the matter.
What Are Your Questions Regarding the New 401(k) Advice Proposal?
Since the DoL’s new 401(k) advice regulations were submitted on February 26th, what are your biggest questions? The most commonly discussed questions have included the following:
- If the statute on how to evaluate mutual funds stands, clearly favoring index funds, how will this change the 401(k) landscape?
- Due to the conflict-free nature of the regs, will advice be limited, or will it open the door for plan providers to move forward with a game plan now that the rules have been defined?
- Will computer model advice be offered by broker dealers, or will they simply partner with an independent third party solution that potentially delivers more value in the eyes of participants?
We welcome your thoughts and ideas in the comments section below.
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