The Markets April 9, 2012

Investment Consultants Recommend Custom TDFs

Over two-thirds (69%) of investment consultants surveyed by PIMCO either support client interest or actively promote creating custom target-date strategies.

Reported by

Rebecca Moore

Others (8%) base their views on whether custom is appropriate for the situation based on specific client factors. Nearly three-quarters (74%) of firms believe it makes sense for plan sponsors with $500 million or less in plan assets to consider creating their own custom strategies. Only 8% of firms believe $1 billion or more in plan assets is needed for custom strategies.

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Over two-thirds (71%) of consultants believe that a custom approach to target-date funds would improve current packaged products. Less than one-quarter (21%) believe there is plenty of choice among current packaged target-date funds.

Consultants believe the top three reasons not to implement custom strategies are difficulty of operational setup, time required to implement and fear of liability, insufficient asset size and asset allocation setup and oversight is too demanding.

In order of importance, consultants report that plan sponsors consider these factors as they evaluate target-date or target-risk strategies: glide path structure, fees, active vs. passive, breadth of underlying investment and performance. Consultants report the following as the most common approaches to benchmark target-date or target-risk strategies: peer group comparison, investment manager index composite and consultant-created index composite.

(Cont...)

An increasing percentage of consultants (65%) believe that tactical asset allocation is a critical to somewhat important component of glide path management. Only about a third (35%) of firms said that tactical asset allocation is not important.

The majority of consultants (78%) believe that investing in Treasury Inflation-Protected Securities (TIPS) is the best risk mitigation approach within asset allocation strategies. Nearly two-thirds of consultants (64%) recommend reducing exposure to assets with highly uncertain outcomes.

Almost two-thirds (65%) of consultants feel that current glide paths are somewhat to highly appropriate, whereas over one-third (35%) believe that current glide paths are somewhat to highly inappropriate (i.e., too aggressive).

Over three-quarters (78%) of consultants believe that the allocation to risk assets (e.g., equities) for those at retirement age (e.g., 65) should not exceed 40%. Nearly one-third of consultants (32%) believe that the glide path should reach its lowest risk allocation (e.g., equities) between the ages of 71 and 75. Just over a quarter (26%) of consultants believe the lowest risk should be reached earlier, between ages 66 and 70. Notably, 16% of consultants cited other factors, such as demographics and retirement age, as driving factors.

There is general consensus among consultants when it comes to loss tolerance for participants at different ages. Almost all consultants cited a loss tolerance of more than 30% at age 25, up to 30% at age 35, up to 20% at age 45, up to 10% at age 55, and between 0% and 5% at the age of 65.

(Cont...)

Almost two-thirds (64%) of firms believe that managed accounts should be an opt-in asset allocation choice only, whereas only 15% believe that managed accounts should be an opt-out investment default (plus opt-in choice). Notably, five firms (13%) believe managed accounts have no role in a defined contribution (DC) plan.

The majority of consultants believe that active management makes sense for all asset classes except large-cap U.S. equities and TIPS. Consultants report that the most important asset classes to actively manage are non-U.S. bonds, emerging-market equities and global asset allocation strategies.

Nearly all (90%) consultants believe that lower cost is the most common factor driving interest in passive investing followed by legal concerns (57%) and communication simplicity (47%).

Nearly all firms (97%) recommend that clients offer a target-date or target-risk investment tier, and 92% suggest that a core fund tier (with both active and passive investment choices) be provided. Sixty-eight percent suggest a brokerage window, with the majority recommending mutual funds only.

(Cont...)

Investment management firms believe that emerging-markets equity (67%), followed by commodities (60%) and then absolute return (including unconstrained equity and fixed income) (57%) would bring the most value as added asset classes within the core or as an addition to an asset allocation strategy.

Over half (52%) of consultants believe that adding global fixed income strategies may enhance plan sponsors’ DC equity offerings. Nearly half (48%) believe that adding global equity and non-U.S. (emerging market) strategies may enhance DC equity offerings, while close to half (45%) suggest that combining equity styles (value and growth) may help. Nearly one-third of consultants (29%) suggest adding a global unconstrained strategy.

The majority of consultant firms (72%) believe that over the next two years it is somewhat likely to highly likely that at least some clients will add a retirement income investment option to their DC plans. Twenty-eight percent believe it is unlikely. Consultants said that retirement income products most likely to attract client interest are stable value, diversified income and a systematic withdrawal program. Consultants’ primary concerns with offering in-plan annuity products include transparency, insurance company default risk, cost and portability.

The PIMCO DC Practice "2012 Defined Contribution Consulting Support and Trends Survey" captures data, trends and opinions from 39 consulting firms across the U.S., which serve over 3,600 plan sponsors with aggregate DC assets of more than $1.8 trillion as of December 31, 2011.

For survey highlights or other PIMCO DC publications, call 888-845-5012 or e-mail pimcodcpractice@pimco.com.

Compliance April 9, 2012

Plan Advisers Should Urge Sponsors to Prepare for 404(a)(5)

Plan advisers should not delay helping plan sponsors prepare for the 404(a)(5) regulation as the deadline looms.

Reported by

Corie Russell

Under the Department of Labor’s (DOL’s) 404(a)(5) regulation, plan sponsors must provide fee information to participants by August 30, 2012. However, with all the attention surrounding the 408(b)(2) regulation—which requires most service providers of retirement plans to disclose information about fees and services to plan sponsors by July 1, 2012—some industry experts think preparation for 404(a)(5) is falling by the wayside.

Fred Reish, chairman of the financial services ERISA team at Drinker Biddle & Reath LLP, told PLANADVISER he is concerned about plan sponsors’ lack of urgency in preparing for 404(a)(5). He said he believes plan sponsors have a misconception that the burden of participant disclosure falls on the recordkeeper. In reality, Reish explained, the recordkeeper is simply a service provider operating under a contract and does not act as the fiduciary. Reish said he thinks many plan sponsors still do not fundamentally understand that they can be liable for participants’ investment decisions.

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“It’s still the plan sponsor’s responsibility,” Reish said. “What [plan sponsors] haven’t really looked at is that the legal burden is on the ERISA plan administrator.”

Reish speculated several reasons that the same urgency in complying with 408(b)(2) has not been applied to 404(a)(5).

Reasons 404(a)(5) Is Being Pushed Aside

One possibility is the nature of the rules. The 408(b)(2) and 404(a)(5) rules have different enforcement mechanisms, he explained; 408(b)(2) is a prohibited transaction rule, in which the relationship between a plan sponsor and service provider must be terminated on July 1 if it is in violation of the rule, whereas 404(a)(5) is a fiduciary rule. If plan sponsors fail to distribute fee disclosure information to participants by the August 30, 2012, deadline, the participants first have to suffer losses from their investments in order for plan sponsors to “run into trouble.”

“The very nature of the rule doesn’t create the same sense of urgency,” Reish said.

Charlie Nelson, president of Great-West Retirement Services, echoed Reish’s concern. “Our general sense from the industry is it’s not as urgent of an issue [as 408(b)(2)], and we’re trying to raise awareness,” he said.

Plan advisers, Nelson added, can help raise this awareness. “Advisers can certainly make the plan sponsor aware of the penalties and consequences of non-compliance, which include personal liability of plan sponsor fiduciaries.”

If participant losses are suffered as a result of sponsors not following the rule, it can result in a potential penalty from the Department of Labor (DOL), as well as the inability to use ERISA 404(c) as a defense, Reish explained.

Another reason plan sponsors have been paying more attention to 408(b)(2) than 404(a)(5) is the awareness of class-action lawsuits evaluating revenue sharing, which Reish said is closely tied to 408(b)(2). He cited Tussey v. ABB, in which the court found ABB Inc. and Fidelity breached some fiduciary duties owed to participants in ABB’s retirement plans (see “Employer to Pay for Failing to Monitor RK Costs”).

Lastly, Reish said media attention has been more focused on 408(b)(2), which he speculates is because that rule applies to almost every service provider, whereas participant disclosure falls on the smaller recordkeeper population.

How to Take Action

So how can plan advisers help sponsors prepare for the 404(a)(5) deadline? Plan sponsors must first be educated on their fiduciary responsibility, Nelson said, and then understand the information their recordkeepers need in order to meet the participant disclosure regulation. For example, small 401(k) plans often use a third-party administrator (TPA) to calculate eligibility, so the recordkeeper must acquire the information from the plan sponsor or TPA.

Advisers should review the information the recordkeeper will provide the plan sponsor for 404(a)(5) to ensure it includes everything required in the disclosure, Nelson said. “Advisers should engage in conversation with recordkeepers to review samples of all fee disclosure documents for their plan sponsors,” he explained. “While actual disclosure documents may not be available today, templates are likely available and should be reviewed, along with the timeline expected for receipt of the disclosures.”

Advisers and sponsors should discuss the timeline in which the disclosures will be distributed and who will be sending them to participants, beneficiaries and eligibles as required, Nelson added.

Annual disclosures, initial disclosures and quarterly statements must be reviewed, Reish said. The retirement plan website must also be examined to make sure all the designated investment alternatives are represented accurately, and that all the required information under 404(a)(5) is included, according to Nelson. “Special attention should be made of challenging areas around unique investment options such as ‘custom’ models, employer stock [and] non-publicly traded investment options to assure required website information will be available,” he added.

Although it is not required by the DOL to offer the investment information on a single website, Nelson said he believes one website is the best practice to make it user-friendly.

Sponsors should determine whether the information seems complete and is also easy to understand, Reish added. “The purpose of the rule is to help participants,” Reish said. “Are [the disclosures] written in a way that participants can understand them? Are they helpful?”

Once the actual disclosures are made available, the sponsor and adviser should review them together before sending, Nelson concluded.