Bridgebay Financial, Inc.

Open Architecture

2012-02-01T12:57:00.000-08:00

By Nicholas Zaiko
Investment Consultant
Bridgebay Financial, Inc.
www.bridgebay.com

As fiduciaries, plan sponsors must act for the sole benefit of their plan's participants. Decisions born of the need for corporate convenience may lead to less-than ideal arrangements or investment options for plan participants. Sponsors need to evaluate whether the convenience of one-stop shopping is worth the potential fiduciary risk of foregoing open architecture.

The conventional wisdom regarding bundled service providers is that the convenience offered by an all-in-one solution is particularly attractive to smaller 401k plan sponsors who might not have the scale or staffing necessary to administer the plan in-house. These types of companies are typically spread thin already, with many individuals wearing many hats. Tight resources tend to push plan sponsors to make the easy choice of working with bundled service solutions. These service providers come in several forms. They can be a broker, a mutual fund firm, a payroll processor or an insurance company.

Truly open architecture goes well beyond the simple ability to add non-proprietary funds to a plan's line-up. In a open architecture, all of the service providers are either unbundled or entirely separate entities. The goal of open architecture is to have the flexibility to monitor and trade out each individual component, independent of the other services with a minimal amount of disruption to the plan. The primary service providers to a typical DC plan include the recordkeeper, investment or fund managers, custodian or trustee, plan investment consultant, managed account provider, and the education/communications provider. Ideally, each of these service providers is a separate, unaffiliated entity without any vested interest in the actions of any of the other providers.

The key is to then take a "best-of-breed" approach and select only the best recordkeeper, TPA, mutual funds and investment consultant. A recent study which compiled the characteristics of an ideal 401k plan supported this approach and demonstrated that such plans do not use bundled providers. By managing each component individually, the sponsor maintains the flexibility to replace any element that may suffer from poorer or declining quality service without disturbing any of the other services. The modular nature and the ability to use best-in-class providers are the major strengths of open architecture.

In contrast, bundled service providers typically rely on investment products to drive revenues, making other peripheral services an afterthought and generally a loss leader. Ancillary services such as plan administration and recordkeeping tend to suffer when pushing investment products is the primary source of revenue.

Additionally, by obscuring the actual cost for each service in the bundled fee, such providers make it difficult to accurately benchmark total plan fees. Independent providers bring with them a built-in check-and-balance mechanism regarding the quality and fees of other service providers. Though many bundled providers may tout the benefits of the "economies-of-scale" that come with their arrangements, the inherent conflicts of interest may actually result in higher fees than a truly open architecture solution.

In recent years we have seen numerous lawsuits brought against plan sponsors for various breaches of fiduciary duty. In 2011 we witnessed the result of the high-profile class action suit against Walmart for breach of duty regarding the investment choices in the 401k plan. The plaintiffs discovered that het plan's bundled service provider had placed high-fee funds into the plan and the broker was receiving trailing commissions for having placed those funds in the plan.

The mere fact that it took plan participants so long to discover the breach of fiduciary duty indicates how well high fees can be hidden within the bundled arrangement. 2012 promises to be a year of greater disclosure and transparency on behalf of bundled service providers. The new fee disclosure requirements outlined under sections 408(b)(2) for provider to plan sponsor disclosures and 404(a) of the Employee Retirement Income Security Act (ERISA) offer to shed light on the bundled service provider. This has the potential to reshape the bundled provider industry and reinvigorate plan sponsors' interest in pursuing open architecture.

While a bundled solution may work for plans of a relatively small size, the modular and best-in-class approach afforded plan sponsors by using open architecture and the potential for lower, more competitive fees must not be ignored.

Selecting and Monitoring Fiduciary Advisors

2012-01-13T15:03:00.000-08:00

By Nicholas Zaiko
Investment Consultant
Bridgebay Financial, Inc.
www.bridgebay.com

Effective December 27, 2011, the Department of Labor's Employee Benefits Security Administration (EBSA) issued its final rule regarding the provision of investment advice to participants in individual account plans, such as 401(k) and 403(b) plans, and beneficiaries of individual retirement accounts. The final rule affects plan sponsors, fiduciaries, participants, and beneficiaries of participant-directed retirement plans. Essentially, the rule enables providers of investment advice acting as fiduciary advisers to offer investment guidance to participants provided certain conditions set forth in the regulations are satisfied.

The Need for Advice
Recent studies have indicated that participants who receive professional investment advice consistently outperform those who go it alone. Constructing a proper asset allocation is key to the long-term success of any retirement strategy and most participants are ill-equipped to make such a potentially life-altering decision on their own. The DOL's new participant investment advice regulation attempts to offer participants another means of achieving their retirement goals.

Not all investment advice that has been provided in the past has been impartial or in the participant’s best interest. Sometimes there have been conflicts of interest unknown to the plan sponsor. In selecting a fiduciary advisor the plan sponsor still retains fiduciary responsibility in selecting the form of investment advice they offer to their participants.

Best Fit
There are numerous factors to consider when selecting a fiduciary adviser to a plan. The last few years have seen dramatic growth in the independent investment consulting industry and with the passage of the new regulation, more solutions are sure to follow. The first step is to determine what type of investment advisory service is the best fit for the plan participants. Traditionally, plans have relied on an eligible investment advice arrangement ("EIAA") through a fiduciary adviser to help employees make informed investment decisions, but this is no longer the only available option.

Third-Party Advice
Web-based investment guidance services and managed accounts offered through an independent, third party are increasingly popular options. These firms are unaffiliated with any of the plan’s fund providers or managers. According to the new regulation, their methodology for building an asset allocation must not be in any way impacted by the funds selected. In other words, they must not have a vested interest in or receive any additional financial benefit from using one fund over another. The methodology must be fund and share class neutral. In order to determine the best option for their participants, plan sponsors should conduct a thorough analysis based on their company's demographics and plan objectives.

Identifying Fiduciaries
Another important factor which is often overlooked in selecting a fiduciary adviser is determining exactly who can act as a fiduciary adviser. Many brokers may offer investment advice to participants but most are protected by regulations from taking on fiduciary liability. In many cases, if the adviser is not receiving compensation directly from the act of offering advice, they are not considered a fiduciary under the current law. Eligible fiduciaries generally come in four categories: a registered investment adviser (RIA), an advisor for a bank providing services through the trust department, an insurance company representative and a representative of a registered broker-dealer. Plan sponsors should check with the fiduciary adviser to confirm their status as an eligible fiduciary to the plan and receive confirmation in writing that they are acting as a fiduciary.

Establish Evaluation Criteria
The next step in selecting a fiduciary advisor is for the plan sponsor to establish objective criteria for evaluating an adviser that fits the needs of its participants. The retirement plan committee is responsible for creating a documented checklist that can then be used to evaluate fiduciary advisers. Some general criteria should focus on identifying any potential conflicts of interest, fee and compensation arrangements that may cause the adviser to pressure participants into less appropriate products. The firm’s experience and depth of services in providing fiduciary advice and specifically the qualifications of the professionals providing the advice are important. Checking for any disciplinary actions against the fiduciary adviser or the firm should be conducted at the onset and on an annual basis for any potential change in status.

The fiduciary adviser’s professional credentials and investment experience are critical. Many large firms may be impressive marquee names yet the individuals providing the advice may be junior, less skilled advisers than small boutique firms whose advisers may be highly experienced professionals providing high caliber advice.

Ongoing Monitoring
Once a suitable fiduciary adviser has been selected, it is important that the sponsor establish a process for ongoing monitoring of the adviser. Best practices dictate that a plan sponsor review their plan's fiduciary adviser at least once a year. There are a multitude of factors to consider, but a prudent approach would include a deep dive of the adviser and documenting their process. This would include confirming that all required documentation and notifications were provided. Another factor to consider would be determining whether the adviser is actually complying with the new participant investment advice regulation.

Revisiting the relative cost of the investment advice program in relation to participant adoption and utilization is a prudent way to quantify the value added by the fiduciary adviser. If participant adoption is relatively low compared to the cost, perhaps more education is required or the plan sponsor may want to scale back on the services offered . A thorough review should also include inquiring into and following up with participant comments and feedback. Any participant complaints should be addressed immediately. Participant feedback, whether positive or negative is a good way to stay ahead of any potential fiduciary liability issues. Fine-tuning the plan based on participant comments may lead to increased participation rates, if done in a prudent way. Updating the firm’s and fiduciary adviser’s status for any disciplinary actions should be part of the annual evaluation.

The most important fiduciary benefit of conducting this due diligence review is documenting the decision making process and the results. Comprehensive documentation of the information collected to render decisions that impact the plan is the best way to protect the plan sponsor from fiduciary liability. While investment returns may go up and down, a detailed accounting of the due diligence process is the plan sponsors' greatest asset. An annual review of the plan's fiduciary adviser will go a long way to fulfilling a plan sponsor's fiduciary duty.

Conclusion
Most participants lack the skill, training or time to construct a disciplined, asset allocated, long-term investment strategy. Short-term trends often lead them to make mistakes and risk their long-term success. Individual investors are driven by emotion, causing them to make the same investment mistakes over and over. The DOL's new participant investment advice regulation attempts to offer participants another means of achieving their retirement goals. Plan fiduciaries are responsible for evaluating and understanding the advice options they offer to their participants. Realizing the plan sponsor's role in delivering this essential service is an important fiduciary duty. Establishing a defined strategy for implementing participant investment advice is key to fulfilling a plan sponsor's fiduciary obligations.

Stable-Value Funds

2011-12-01T15:52:00.000-08:00

By Janice Phan
Director of Treasury
Dolby Laboratories, Inc.
and
Linda Ruiz-Zaiko
Bridgebay Financial, Inc
www.bridgebay.com

Stable-value funds have played an integral role in employer retirement plans and have evolved, growing in complexity and structure. Despite issuer downgrades and constraints on wrap capacity, demand for stable-value funds continues to be strong as participants seek safety from the volatility of equity markets. This article examines the unique characteristics of stable-value funds and identifies the benefits and potential downsides of this in-vestment strategy.

Until the financial crisis, stable-value funds were considered a conservative investment option, being a hybrid asset class that produced bond-like returns while seeking to maintain a stable principal value. The advent of the financial crisis exposed several structural weaknesses and caused numerous detrimental plan events that negatively impacted these funds.

Today, stable-value fund providers face countless challenges including limited wrap capacity, restrictive investment guidelines, higher wrap fees and exceptionally low yields.

Background
Prior to the financial crisis, banks and insurance companies considered wrap insurance contracts to be a highly desirable source of revenue. Competition for this coveted market rapidly grew, resulting in increasingly thin wrap fees or insurance premiums as wrap providers took on increased risks by insuring a broader range of riskier asset classes without differentiating for potential risk/returns. The plan sponsor benefited from the low fees and excellent yields with perceived principal protection.

During the financial crisis, the prices of the underlying assets dropped dramatically (yields on bonds rose sharply) causing market-to-book ratios for many stable-value portfolios to plunge below 100%. Contractually, wrap providers insure the difference between the market and book value of a plan and have to step in to provide capital when the market value is significantly below book value.

What is a Stable-Value Fund?
Today’s stable-value fund is typically a high-quality, diversified portfolio of fixed income in-vestments that includes U.S. Treasury and Agency securities, corporate bonds, asset-backed and mortgage-backed securities held in commingled bond trusts or mutual funds.

Another variation of the stable-value fund is the synthetic GIC (guaranteed investment contract) which consists of a fixed-income portfolio and a wrap contract issued by a bank or insurance company that guarantees the principal.

Stable-value funds generally are available as separately managed accounts or commingled funds.

Separately managed accounts are comprised solely of the assets of a specific DC plan managed to their unique investment guidelines. No other plan assets are in the account. Commingled funds, similar to mutual funds, combine the assets of multiple unrelated DC plans in one fund.

There are restrictions that apply to the fund's liquidity provision called the "equity wash rule" or competing fund rule that forbids any redemption out of the stable-value fund into a "competing" fund such as a money market fund or a short-duration bond fund (typically less than 3.5 year duration). Long duration bond funds and equity funds are considered noncompeting funds and money must stay at least 90 days.

Book Value Accounting
Stable-value funds seek to maintain a $1 per unit price. Interest is credited to the account. These funds use book-value accounting to smooth out any difference in market values and provide a stable net asset value (NAV).

A successful stable-value fund relies on having well-capitalized and financially sound wrap providers, close tracking of the market-to-book value ratio and reasonable cash flows to insure liquidity and participant withdrawals without principal loss.

Participant directed withdrawals from the stable-value fund are made at book-value rather than market value. This works well for the fund when the market values are higher than the book values but is problematic when market values fall below book values. When the market-to-book value ratio drops below 100%, the wrap provider insurance may be triggered to pay out the participant at book value or principal.

During the turbulent financial crisis, the market value of the underlying securities in many stable-value funds fell below the book value triggering the guarantees.

Wrap Provider Exposure
Stable-value funds have unique structural risks that differ from fixed income bond funds. The fund's reliance and exposure to wrap providers can be quantified as the difference between book value and market value of the underlying investments. As the market-to-book value ratio falls below 100% the risk to the wrap provider grows because the provider is required to make up the difference in order to provide liquidity.

Employer-Initiated Event Risk
Event risk arises when the market value is below the book value and a plan level or employer-initiated event other than a termination occurs. During the crisis, layoffs, mergers, divestitures, plan changes and bankruptcies triggered "plan events". Many contracts enable wrap providers to pay participants less than the book value (principal) at redemption when employer-initiated events occur.

This plan level event risk was significant in separately managed stable-value funds that were dedicated to a single plan. Commingled stable-value funds that pool the investments of multiple, unrelated plans fared better.

Stable-value funds have been widely used yet not fully understood as to how various events are treated by book value guarantee providers (wrap providers). Even some of the retirement plan consultants advising DC plans on the fund selections were not well versed on the wrap provider covenants until the plan was notified of a potential violation.

Employer-initiated events can lead to payments to participants at market value, which during recent times of stress, have been below book value.

Fortunately, plan sponsors are now generally more discerning of the creditworthiness and financial strength of the wrap provider while historically, fees had been the most significant criteria for selection.

Insurance Costs Rising
Stable-value portfolios have been traditionally insured by insurance companies. As a result of poor fixed income performance and pricing, heightened market volatility, and increased capital requirements, many wrap providers have raised fees, tightened portfolio requirements or exited the market altogether.

New wrap capacity entering the market consists of insurance companies that are charging 2-3 times the fees previously charged. Wrap insurers are also requiring that their asset management services be used as part of the stable-value program in order to gain access to wrap capacity.

Many wrap providers have exited the market because the margins are too thin or they lack sufficient capital or resources to maintain this exposure. Issuer downgrades, constraints on wrap capacity, and low fees are limiting the availability of stable-value funds.

Regulatory Impact
New regulations present new and ongoing challenges to the stable-value market. The financial crisis triggered bank regulatory reforms with the introduction of Basel III and Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) in July, 2010.

These regulations have prompted bank wrap providers to re-evaluate the market and reduce their wrap insurance exposure. As some banks have exited the wrap business, a number of insurers have re-entered the market.

Declining yields exacerbated by higher expenses and wrap fees make these complex and less transparent investments less desirable in the current market environment.

Conclusion
Plan sponsors that have a stable-value fund option in their DC plan should understand the structure of this investment option, new developments in the wrap issuer market and the risks associated with this perceived "safe" option. A review of the stable-value documentation should focus on under-standing what events may trigger a violation of the wrap agreements, causing a potential market value adjustment (loss). Any clauses that could impair the coverage provided by wrap providers should be understood. Enhanced, timely re-porting and transparency to the underlying investments for quarterly reviews should be available to the plan sponsor to ensure consistent due diligence.

Plan sponsors should re-evaluate the stable-value option within the plan's current fund line-up to determine if it still meets the needs of the plan's participants. A short bond fund that provides current income, minimal principal volatility and the flexibility to transfer money may offer a less complex and more transparent investment alternative for a plan sponsor to monitor.

Design Trends in QDIAs After the Financial Meltdown

2011-11-09T19:35:00.000-08:00

Presentation Handouts Now Available

Presented at the National AFP Conference on:
Tuesday, November 8, 2011
Boston, MA

Presented by:

Linda Ruiz-Zaiko
President
Bridgebay^SM

Patrick Baumann
Assistant Treasurer
Harris Corporation

Ashish Gandhi
Product Mgr. DC Solutions
Northern Trust

This session covered the evolving trends in target-date funds, risk-based asset allocation, balanced accounts, managed accounts and other QDIAs. Hear insights on QDIA issues and DoL regulations. Are providers changing their products in response to these regulatory initiatives? Have plan sponsor perceptions of QDIAs shifted? Learn what elements of these solutions pose the greatest challenge for plan sponsors and their participants.

QDIA Design Trends After the Financial Crisis

2011-10-19T10:56:00.000-07:00

By Linda Ruiz-Zaiko
Bridgebay Financial, Inc.
and
Janice Phan, Director of Treasury
Dolby Laboratories, Inc.

The Pension Protection Act (PPA) of 2006, created qualified default investment alternatives (QDIA) and expanded the 404(c) "safe harbor" protections for defined contribution (DC) plan sponsors. QDIA's include target date funds, target risk funds, balanced accounts, managed accounts and grandfathered stable value funds.

The financial crisis that still lingers today, has prompted plan sponsors, recordkeepers and participants to reassess the risk-reward profiles of their retirement investments.

The sweeping changes of the Pension Protection Act of 2006 prompted plan sponsors to quickly implement improvements. Yet the continuing onslaught of legislative, regulatory and disclosure measures suggest that it may be time to rethink their DC plan design, educational programs and investment offerings. The introduction of Roth 401(k), Roth 403(b) and conversion rules have increased participant choices but complicated the education programs.

Recordkeeping innovations have enabled plan sponsors to add funds at a furious pace. Yet a plan with a large number of funds may be as sub-optimal as one with too few choices. Many plans may have an unintended gap in their investment menus. Conversely, the plan sponsor may want to proactively minimize overlaps and redundant funds in asset categories.
The rapid asset growth of QDIAs and financial crisis have prompted significant changes to these ever-evolving investment strategies. Many investment managers have added asset classes to their allocations in an attempt to reduce correlation between assets and dampen volatility.

Target Date and Target Risk Funds
By far the most widely adopted QDIA by plan sponsors, target date funds continue to attract the majority of plan assets. The use of target date funds in DC plans has surged and are most popular with new hires and younger participants according to the Profit Sharing/401(k) Council of America.

Many plan sponsors have replaced balanced funds that have a fixed asset allocation and may not be suitable for all participants with target date funds whose asset allocations vary by age and change over time.

Many plan sponsors, relied on their recordkeeper's proprietary target date fund recommendation without vetting the extent to which the underlying funds and asset classes deviated from their core menu of funds. The financial crisis uncovered the performance differences among target date funds and the impact of high allocations to equities and volatile asset classes. Different glidepaths produced drastically different results, prompting plan sponsors to reconsider their target date funds, underlying asset classes and allocation assumptions.

In response to the financial crisis, many target date managers have changed their investment strategies and underlying assets. Some changes were implemented to increase diversification, mitigate downside risks and add uncorrelated assets. The most common changes include the introduction of inflation hedges, including TIPS (Treasury inflation-protected securities), REITs (real estate investment trusts), natural resource and commodity linked instruments, derivatives, currency swaps, emerging markets and high-yield bonds.

These changes have been marketed as being consistent with the previous asset allocation, yet they constitute a significant shift that should be evaluated and understood by the plan sponsor. Recently, the DOL pronounced that target date fund investment managers are not fiduciaries to the plan, yet they are permitted to make decisions that impact participant returns without consulting plan fiduciaries.

Design Trends in Qualified Default Investment Alternatives (QDIA) After the Financial Meltdown

2011-09-08T21:38:00.000-07:00

Join us at the 2011 Association for Financial Professionals National Conference in Boston, MA on November 8th for our presentation.

Presnted by:

Linda Ruiz-Zaiko, President
Bridgebay Financial, Inc.

Janice Phan, CCM, Treasurer
Dolby Laboratories, Inc.

This session will cover the evolving trends in target-date funds, risk-based asset allocation, balanced accounts, managed accounts and other QDIAs. Hear insights on QDIA issues and Dol regulations. Are providers changing their products in response to these regulatory initiatives? Have plan sponsor perceptions of QDIAs shifted? Join this lively discussion and learn what elements of these solutions pose the greatest challenge for plan sponsors and their participants.

Conference Brochure

www.AFPconference.org

Investment Traps and Risks

2010-09-30T16:15:00.000-07:00

	Presentation Handouts Now Available Presented: Friday, September 24, 2010 The Palace Hotel San Francisco, CA Presented by: Nicholas Zaiko Investment Consultant Bridgebay^SM
Understanding the underlying characteristics, features, and structures of securities is critical in discerning potentially volatile or inappropriate investments for corporate liquidity portfolios. We'll explore risk-controlled practices that can help avoid potential problems.

Fund Performance is Just the Beginning

2010-06-28T13:56:00.000-07:00

By Nicholas Zaiko
Investment Advisor
Bridgebay Financial, Inc.
Bridgebay.com

Many treasury professionals sit on their employer's 401(k) Retirement Plan Committee and share the responsibility of monitoring and reviewing their plan's investments. Most plans have investment advisors that provide the expertise in selecting, tracking, and replacing investment funds. As a member of the Committee and a fiduciary, it is also important for you to have a disciplined understanding of your advisor's due diligence and evaluation process for recommending investment funds for your retirement plan.

The ever-expanding universe of available investment funds is making the task of selecting the proper funds for retirement plans increasingly difficult. With so many from which to choose, plan sponsors may be making choices for the wrong reasons.

Evaluating performance is merely a first step in selecting a mutual fund. Past performance is the primary basis of most fund evaluations, but is insufficient as the sole means of measurement. Morningstar and other third-party ratings rely heavily on historical performance against a peer group when rating funds. Additionally, many sponsors make long-term decisions based on short-term performance. While this is one important feature to keep in mind, there are numerous other criteria to consider when building a 401(k) fund line-up.

As a quantitative measure, performance alone ignores the many important qualitative factors that will impact your plan over the long run. A fund's management team, investment style and risk level are even more important than pure performance.

As a fiduciary, it is your responsibility to act as a "prudent person" which means drilling down beyond superficial performance measures when selecting funds. While there are many qualitative factors to consider, we will discuss some of the most significant.

Manager Turnover
It is important to know that the people who were making the investment decisions in the past will be the same people making the decisions in the future. When participants invest in a fund they are actually buying into the knowledge, experience and assumptions of the management team. In many cases, a fund's track record may have been generated by a manager that is no longer involved with the fund.

Knowing that investors are mindful of management changes, firms will claim that key investment professionals were simply a small part of a much larger team and attempt to reduce their perceived role in the investment decisions.

A management change does not mean that a fund should be automatically eliminated from consideration, it simply means that further research is required. The new manager should ideally have a minimum of three to five years of experience with expertise in the same asset class and sector for which he or she is taking over.

Investment Style and Style Drift
While it may be hard to ignore the infatuation with the high flyers, studies have shown that 95% of long-term performance is attributable to asset allocation. Selecting a fund that stays true to its intended style without migrating too far from its asset category is more important to a participant's portfolio than peer ranking. Value and growth styles shift in and out of favor over time.

Providing participants with a wide array of asset classes to allow proper diversification is key to the long-term success of their retirement strategy. As funds drift in style, their holdings may overlap other funds in the line-up, reducing diversification through increased correlation and effectively increasing risk. A 401(k) menu composed of funds that have a lot of overlap won't allow participants to create well diversified portfolios.

This makes monitoring style drift of paramount importance to plan fiduciaries. It is relatively easy for a fund to slip out of its style box and in most cases is unintentional. Style drift is most prevalent with small cap stock funds because as small cap companies mature, they drift into the mid-cap range and tend to move from growth to value.

A mid-cap value fund masquerading as a small cap growth fund won't provide the proper risk-reducing benefits of diversification.

Risk and Volatility
Volatility is a roller coaster ride that most plan sponsors and participants seek to avoid. The most common measure of volatility and risk is standard deviation which describes the amount the performance of a fund fluctuates in up and down markets. For the most part, participants are willing to forgo some upside potential if they are also protected from extremely poor results on the downside. Other statistics that measure risk include Sharpe ratio, Beta, and R2. These figures describe the amount of risk taken per unit of return, the degree to which the funds' performance is correlated to the market and the rest of the plan line-up.

Fund concentration also plays an important role in volatility. Diversification tends to reduce volatility but a large allocation to a single stock or sector may deliver higher than average returns or larger than expected losses.

Investment Manager Compensation
The incentives for a fund manager must be in line with the strategy of the fund and the philosophy of the plan sponsor. Managers can be compensated in various ways, encouraging different types of behavior. Risk-taking to achieve high returns can lead to higher volatility than a manager that is compensated for consistent, methodical returns.

The structure of a manager's compensation can lead to style drift. A manager being compensated based on short-term results may turn to aggressive risk-taking as a means of boosting performance. This means that the fund may venture away from its stated style if that style is currently out of favor.

Fees and Revenue-Sharing
A critical fiduciary responsibility in fund selection is fully understanding the all-in fees and revenue-sharing arrangements for each fund.

This task is complicated by the need for fees to be "reasonable." Revenue-sharing arrangements are the primary components of "hidden" fees. These arrangements are different from fund to fund and impact participants directly. What might seem to be a "free" plan to the plan sponsor may in fact include funds in the highest-cost share class, shifting high costs of the plan and administration onto the participants.

Balancing the needs of the participants and the needs of the plan sponsor are key to establishing and understanding reasonable fees. Plan costs can be recaptured and used for the benefit of the plan participants. A balance should be struck between high and low-cost funds to deliver the appropriate services at a reasonable cost.

Delving Beneath Performance
It is clear that measuring performance is merely one small part of the investment fund evaluation process. As a fiduciary, it is imperative to perform both a quantitative and qualitative analysis.

Relying solely on historical performance is a one-dimensional approach to solving a multi-dimensional problem. While still a significant measure, style drift, manager compensation, risk and volatility, manager turnover, and fees are often times much more impactful.

Properly evaluating these qualitative measures may take additional time and resources, but is a critical component of the fiduciary due diligence process. Evaluating performance is just the first step in selecting a fund. Delving deeper, to discover how that performance was achieved will provide the critical insight necessary to make the right decisions for your plan and participants.

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Simple Steps to Being a Stellar Plan Sponsor

2010-06-15T09:25:00.000-07:00

By Barbara Williams, CFA
Bridgebay Financial, Inc.

Bridgebay.com

Based on our experience in working with pension and retirement plans and meeting with providers and plan sponsors, we have seen there is frequently a difference between the requirements of the law and the steps needed to keep your plan in top shape. By following these basic guidelines, your fiduciary responsibilities as a plan sponsor will be greatly enhanced.

Establish & Update an Investment Policy Statement (IPS) That is Consistent With the Plan
Plan advisers and consultants advise plan sponsors on the importance of having an IPS to establish a prudent process. Plan fiduciaries will find it much easier to ensure an objective, well-documented, process to monitor and conduct the plan's investment activities in accordance with a set of written, established, prudent standards. The most important aspect of the IPS is to follow it and abide by its standards. DOL examiners routinely begin an audit by reviewing the IPS. They check that the Plan is being managed in compliance with the IPS and plan document.

Form & Convene a Well-Informed Plan Investment Committee
ERISA states that the named fiduciary of the plan (an individual or a committee) must make “prudent expert” decisions that are in the best interests of plan participants and beneficiaries. ERISA allows you to form a committee or utilize outside experts to help you make these decisions and that is recommended. ERISA has a personal liability clause so make sure your committee members are knowledgeable and willing to participate in the decision-making responsibilities for the plan.

The committee must meet regularly in order for the plan to be properly and prudently managed as the law requires. A written record such as minutes of the meetings is an essential item in documenting the results and deliberations. These minutes can provide committee members with a history of the proceedings, the alternatives and recommendations presented, as well as the decisions made.

Fiduciaries Should Understand Their Roles and Responsibilities
The most important thing is to understand who the plan fiduciary is--who has the ability to control and influence the plan assets. A fiduciary is any person or entity named in the plan document (e.g., the plan sponsor and trustee), any person or entity that has discretionary authority over the management of a plan or its assets (all individuals exercising discretion in the administration of the plan, all members of a plan’s administrative committee and those who select committee members), and any person or entity that offers investment advice with respect to plan assets, for a fee.

Importantly as plan sponsor, the authority to appoint a fiduciary makes you a fiduciary - and that hiring a co-fiduciary does not eliminate your fiduciary duties. If you are a fiduciary and you feel that you lack the expertise to make those decisions, you are expected to hire someone with the professional expertise to carry out the investment and monitoring functions for the plan.

Proactively Monitor the Plan Investments and Replace Underperforming Funds
Whether or not you have a written IPS, the committee is expected to conduct a review of the plan’s investment options and eventually that review will turn up a fund that no longer meets the criteria established for the plan. A written IPS will provide you with the discipline to place that fund on a “watch list” or drop the fund completely and map any participants’ balances to a new, more appropriate fund one that meets the plan’s criteria.

By misunderstanding the qualifications for 404(c) protection, many plan sponsors think their plan meets the standards of ERISA 404(c), a provision that protects them from being sued for participant investment decisions, as long as certain conditions are met.

You may be covered from an individual participant’s claim, but industry experts have expressed concern that very few plans meet those standards and offer no protection from a participant’s suit predicated on an inappropriate investment option. The Department of Labor assumes you are responsible for every participant investment decision except those behind the 404(c) “wall.”

Know What's in Your Target-Date Funds
Target date funds now represent the single largest asset category in most 401(k) plans and are typically designated the QDIA. Currently the DOL has opined that the managers of TD funds are not fiduciaries Investment Committee members are fiduciaries yet TD investment managers are not fiduciaries of the plan. Yet, the plan sponsor has no choice in the TD funds' selection of the underlying assets (commodities, high yield, emerging markets) included in the plan's target date funds when they are the only suite of funds offered by a bundled provider. Some legislators want to change this to make fiduciaries out of the money managers who make the asset allocation decisions and manage the assets since they have sole discretion in making investment decisions.

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Building a Viable Investment Committee

2007-06-03T16:37:00.000-07:00

By
Marlow Kee, CPA
Director of Finance
PATH
www.PATH.org

Barbara E. Williams, CFA
Managing Director
Bridgebay Financial, Inc.
www.bridgebay.com

Overview
Building a retirement investment committee takes significant planning on the part of the plan sponsor. An investment committee is responsible for the structured review and analysis of a retirement plan and the investment options that are offered to employees.

ERISA mandates that in structuring plans, the investment committee be at the heart of questions about providing the best investment choices that meet the needs of the plan participants. ERISA qualified plans mean the plan sponsors act as plan fiduciaries making decisions and adopting the perspectives and methods in a prudent manner.

This is especially true in choosing investment plan options as few plan sponsors employ only one person who could take on the function of “prudent expert” in selecting, monitoring and replacing investment funds for their retirement plan.

As a result, building an investment committee is the best way to protect and serve the plan participants because it provides a rational approach with different viewpoints for fiduciary decision-making. In selecting and removing an investment option from the plan, a committee approach is the most disciplined way to make these changes.

It’s important to realize that ERISA mandates that individuals who are fiduciaries are personally liable for their decisions. That personal liability is not easily delegated to another person and in many cases not covered by insurance. The “prudent expert” rules require fiduciaries to make sound and “right” decisions and that usually requires engaging in an appropriate process with multiple viewpoints.

Structuring the Investment Committee
Effective investment committees take into account advance planning in the form of a written committee charter that establishes the basis for all committee operations and includes by-laws and operating procedures. This is in addition to having an Investment Policy Statement (IPS) to govern how the committee selects and monitors investment choices.

The committee charter should identify the roles of committee members such as:

Which committee members have a vote?
What committee members provide specialized input but do not actually participate in committee decisions?
What are the responsibilities of the chairperson?
How will members of the committee be appointed and for what length of time?

Each committee member is a co-fiduciary with all of the other members of the committee and can greatly impact the committee’s dynamic and ability to perform effectively. The committee should ensure that all relevant materials are sent to the committee members well in advance of regularly scheduled meetings. Additionally the committee should engage experts in certain investments to present at the meetings to ensure that the committee is aware of its fiduciary responsibilities. As “prudent experts”, fiduciaries are judged not on the outcomes of their decisions but on the prudence of the process they used to reach those outcomes.

A committee member’s co-fiduciary status makes all choices very important. Often a plan sponsor will choose individuals who hold specific responsibilities as employees in the organization such as employees from finance (for financial expertise), human resources (for a benefits oriented perspective) and rank and file employees (for an overall participant perspective). Although these individuals may be appropriate from a plan sponsor perspective, they may be inappropriate from a fiduciary perspective. ERISA mandates that fiduciaries must:

Operate exclusively in the best interests of the plan and its participants and to provide the benefits described in the plan documents
Perform as “prudent expert”
Diversify plan assets to minimize the risk of large losses
Must select investment options so participants can structure investment portfolios appropriate for themselves
Abide by the terms of the written plan documents

Having committee members who understand these obligations and are willing to put aside their personal, as well as employer-related interests, is critical for determining who should be on the committee. Sometimes, the best committee members are not necessarily the ones who are at the top of the organization, such as the CEO’s, CFO’s or COO’s, as their committee presence may place them in the awkward position of having to choose between their obligations as a corporate executive and their obligations as a fiduciary member. Also, having rank and file committee members on the committee will only be beneficial if they have some knowledge of the plan and they are willing and able to do the preparatory work for meetings. If they are only on the committee to obtain employee buy-in or improve employee relations, then they are not appropriate members for the committee.

The Investment Policy Statement
The Investment Policy Statement (IPS) is also an important part of the fiduciary responsibilities of an investment committee. An IPS is a legal document designed to describe the goals and strategies the investment committee will adhere to when selecting, monitoring and replacing investment managers of funds. Drafting an Investment Policy should involve a discussion of the duties and obligations of the committee members, the specific committee process for adding and changing managers and the objectives of the decision making process. The IPS should not be too restrictive or too lenient in terms of making the investment decisions. For example, mandating that all investments must return a stated amount over a specific benchmark every year would restrict the universe of funds or managers considered and not take into consideration other equally important criteria including manager strengths, volatility, expense ratios and style analysis.

How many funds should a plan offer? This is a continuing issue in plan design and no set number is always the correct number. Demographics of the plan participants and diversification are key. A starting point for all plans is to offer domestic equity funds, fixed income funds and stable value options. In addition, a target retirement or lifecycle fund is helpful in allowing the participant to choose one fund based on his retirement age which will diversify his assets. The more difficult decisions for the committee are which additional types of funds should be available such as international funds, junk bonds, emerging markets, REIT’s and convertible funds. Based on the fiduciaries’ understanding of the participants needs, these questions are dealt with at the investment committee meetings.

Implementing an Effective Investment Committee
The key to maintaining a productive investment committee is to hold regularly scheduled meetings which follow a pre-set agenda with all members present and willing to participate in an educated discussion. Most committees have a chairperson to ensure the topics are covered in a timely and organized manner. Since the committee and each of its members function as fiduciaries and must abide by the “prudent expert” standard, a record of all its discussions should be made and the meeting minutes preserved to record the committee’s actions. The minutes can also be used to demonstrate that a prudent process was followed in regards to adhering to the IPS. For example, a “watch list” can be established for investment options that fail to meet established criteria and the committee can monitor this list regularly and take action on underperforming investments.

A useful fiduciary checklist for investment committee members is as follows:

Members are prepared and understand their responsibilities
Committee meets regularly and maintains documentation pertaining to its investment decisions
Committee considers the needs of all participants when making investment options decisions
Committee has prepared an Investment Policy Statement and ensures it is properly executed
Committee follows a consistent due diligence process in selecting investment options
Committee periodically reviews each investment option and all fees and expenses associated with the plan

Evaluating the Success of the Investment Committee
The key to sustaining an effective committee is to maintain a consistent process that regularly reviews the needs of the participants, current market conditions, industry trends, changes in pension law, and developing IPS goals. As the demographics of the work force evolves, the needs of the participants change. A younger work force will be more interested in long-term growth investments and an older work force will be more willing to invest in income-oriented investments. This means the investment committee has to continually ask how its decisions will affect the participants. Changing market conditions also are important to monitor as a steadily growing economy may mean participants want plan options that will allow them to structure a more aggressive portfolio.

Current industry trends could include the recent development of target retirement funds that provide an asset allocation based on the time horizon a participant has until retirement. Changes in pension law could mean that plan sponsors could now offer Roth 401(k) plans as well as traditional 401(k) plans. In Addition, strategies should be continually reviewed to ensure that they are aligned with IPS goals.

A successful investment committee is one that has been structured in a thorough manner with a clear understanding of the plan’s goals and objectives. An effective committee schedules regular meetings with advance notice and takes into account the changing needs of the participants, the markets, the industry and the IPS goals. Above all, a successful investment committee puts aside the personal biases held by its members and does what is prudent for the participants in the plan.