Data & Research June 16, 2015

GAO Finds Overactive Participant Trading Is Rare

Retirement plan participants seldom engage in too-frequent or inappropriately coordinated trading.
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A report from the U.S. Government Accountability Office (GAO) finds 401(k) plan participants often face trading policies that restrict frequent or collective trading in mutual funds.
 
GAO reports often criticize current business or regulatory practices—for example when the watchdog group published a 2013 report alleging widespread impropriety among individual retirement account (IRA) service providers targeting qualified plan rollovers. But a new report on in-plan trading restrictions suggests current regulation “strikes an appropriate balance between a participant’s ability to manage his or her retirement investments and the duty of plan fiduciaries to operate and manage their plans prudently, at low cost, and solely in the interest of participants, and the obligations of mutual funds with respect to all their investors.”
 
GAO found the most common restrictions placed on participant-driven trading in 401(k) plans come in two forms. First are “discretionary provisions found in mutual fund prospectuses that allow mutual funds to reject purchases or exchanges of mutual fund shares they find inappropriate or disruptive to the fund’s investment and management strategy.” The other common form of restriction places a time limit on how quickly a participant can purchase additional shares of a given mutual fund after he or she traded out of the fund.
 
With these restrictions in place, GAO found frequent and collective trading by plan participants is uncommon. “Since the market timing abuses in mutual funds of the early 2000s, neither frequent nor collective trading by participants has been a concern for plan sponsors, mutual funds, or participant advocates that [we] interviewed,” GAO says.
 
GAO conducted the study to examine whether problems that arose in the early 2000s have been adequately addressed by retirement plan administrators and the investment companies that sell mutual funds to participants. At that time, GAO explains, “federal regulators identified patterns of short-term trading abuses in mutual funds, including certain undisclosed market timing practices.”
 
NEXT: Problems from the past 

Such practices compromise the savings of long-term investors because they have the potential to dilute the value of mutual fund shares, disrupt the efficient management of a fund’s investment portfolio and increase net fund costs. GAO notes that, in response to these practices, federal regulators adopted rule changes requiring mutual funds to disclose any frequent trading policies in their prospectuses and to permit the imposition of redemption fees of up to 2% of the sales price for fund shares redeemed within a short time period.

The report goes on to acknowledge that some participants in 401(k) plans are skilled enough to actively manage their retirement accounts to seek higher returns, but most are not. Participants who take charge of their own trading often incur additional fees or face trading restrictions due to, for example, trades they make based on third-party investment advice.

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“At times, the objectives of plan fiduciaries and of mutual funds may seem in conflict with those of plan participants,” GAO says, but in general the restrictions put in place by plan officials and investment providers work in favor of participant returns. Again, it’s highly unlikely that a participant could predict short-term market movements with the consistency required to make this a reasonable long-term investment strategy.

The findings are gleaned from extensive interviews with government officials, academics, industry representatives, officials at mutual funds, retirement plan recordkeepers, participant advocates, and retirement plan sponsors representing a range of industries and plan sizes. GAO also reviewed trading policies found in a non-generalizable sample of 15 mutual fund prospectuses and five summary retirement plan documents.

The full report is available for download here. 

The Markets June 16, 2015

PSNC 2015: Optimizing the Investment Menu

Are investment menu consolidation and simplification in the best interest of plan participants?
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Implementing a best practices process for investment selection and ongoing monitoring can mitigate fiduciary liability and will ensure that participants have a better chance of reaching their retirement goals.

Offering fewer investment options on the plan menu is better for participants says Richard A. Davies, senior managing director—defined contribution and co-head of the Institutions North American Client Group at AllianceBernstein at the annual PLANSPONSOR National Conference in Chicago.

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“Many people in the industry talk about a three-tiered investment menu,” Davies said. “Instead, we’re in a camp of 10 options—plus a managed account or brokerage window. Streamlined investments work for 95% of participants” Davies says.

If participants have too many options, it becomes very difficult to make a decision, concurs Michael Riak, principal, head of U.S. defined contribution at Pantheon Ventures who previously worked as a plan sponsor for a large corporate plan. “We got rid of retail funds and instead create white-labeled funds,” Riak said. “You can use comingled funds or create a custom target-date suite. We used hedge funds, currency overlays and other alternatives, creating a great engine. I’m a big advocate for reducing the amount of fund options and using the best possible funds.”

Next: Active Versus Passive Funds

When contemplating whether to use active or passive investments, Davies says that in the past it was simply one or the other approach. It was almost a religious debate. “Now there is more intelligent conversation regarding intermingling active and passive, and you see that on the plan menu," he says.

Davies continued: “You leave too much on the table by not going active. But there’s a question of getting the right mix. There were people who went purely passive, post financial crisis. Now the pendulum is swinging back to using global bonds, U.S. small cap funds, emerging markets and adding [other] active management [options] back to their plan menus or custom portfolios. This is a healthy trend."

"I understand the conversation and concern about fees," Riak said, “but we should be looking at net returns. There is a retirement crisis. Defined benefit plans are going away. New people coming into companies are not being offered pensions. DC plans are the most important way for people to save for retirement. Help participants by using alternatives in good times and protect them by using alternatives in down times. Use the funds that DB plans have used successfully outperforming DC plans significantly for years."

Next: The Right Allocation

Toni Brown, senior DC specialist at American Funds agrees with Riak that "putting extra effort into finding the right allocations can make a huge difference on outcomes for participants. Unfortunately, she says, many people in the industry do what is easy and safe. When you look at the possible aggregation results for participants over time of even a few basis points, it’s worth the time and energy."

Brown said that “by giving guidance to plan sponsors, the Pension Protection Act (PPA) did three great things to refine asset allocations on the investment menu and to better serve participants—auto enrollment, auto escalations and defining the QDIA. Importantly, these are all asset allocations of some form since they take the decisions away from participants. Plan sponsors have adopted them, and participants have embraced these tools. Once the money is in the plan, participants can get a good return.

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