Compliance April 18, 2013

Budget Puts the Squeeze on Adviser Exams

Without significant changes, the SEC cannot fulfill its mandate for examinations of investment advisers, said Elisse Walter, commissioner of the Securities and Exchange Commission (SEC).
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 At a public conference in Washington on Tuesday, Walter said there simply are not enough examiners to go around—and that the Office of Compliance Inspections and Examinations (OCIE) is able to examine only about 8% of advisers annually. This figure includes many of the larger and complex advisers that are examined more frequently, she noted, and pointed out that in comparison, about 50% of broker/dealers are examined each year by the SEC and FINRA.

“We should have an ability to conduct on-site exams of even more advisers, even those that seem to present little apparent risk,” Walter said.

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Walter noted the general complexity of the advisers for whom they have oversight. Assets under management of advisers registered with the SEC are nearly $54 trillion. “We now have responsibility for advisers to many of the world’s largest and most complex entities,” she said.

Size alone of new registrants is not the only challenge. “We’re responsible for collecting and analyzing far more information than we have in the past,” Walter noted. SEC-registered advisers to hedge funds and other private funds must now submit Form PF, which provides information related to systemic risk. Data is then provided to the Financial Stability Oversight Council, as required by statute, and the SEC also uses it for investor protection purposes. “Having more data is an excellent development, but it does further strain resources,” Walter said.

(Cont’d...)

Examination resources for advisers are facing ever-stiffening competition. Further straining the budget is the need to examine other new registrants, including municipal advisers and security-based swap entities—but the increased responsibility was not matched with additional resources, stretching even thinner the commission’s ability to examine advisers with reasonable regularity.

Pointing to the SEC’s 2011 report to Congress, Walter brought up potential solutions, including the imposition of a user fee on advisers or creating a self-regulatory organization. Of course, she noted, “a substantial increase in the SEC’s budget could address the issue as well.” But she did not advocate for any solution in particular, emphasizing that she was advocating on behalf of investors. “One of the solutions must be pursued today,” she said.

Although zeroing in on advisers who, targeted for their size or practices, appear to present a greater risk to investors, can be effective, “targeting risk is not enough. There is frankly no substitute for what we learn and can detect through an on-site examination,” Walter said. “We should have an ability to conduct on-site exams of even more advisers, even those that seem to present little apparent risk.”

Products April 18, 2013

Designing a Better DC Investment Menu

The Defined Contribution Institutional Investment Association (DCIIA) released a white paper that examines how to design investment menus for defined contribution (DC) plans.
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The paper, “What’s on the Investment Menu? A Recipe for a Better DC Design,” discusses the investment objectives and philosophies of various plan sponsors. According to Lew Minsky, executive director of DCIIA, “While all plan sponsors are striving to provide their participants with the best opportunity to reach a dignified retirement, there is no right or standard approach to achieve this objective.” What each plan sponsor needs to do, said Minsky, is determine their philosophy for running the plan and then establish objectives that align with this philosophy.

Go It Alone or Ask for Help? 

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But to achieve an investment menu that works for their plan and participants, is it enough for a plan sponsor to simply follow a checklist of objectives or should they bring in outside help (e.g., financial advisers, and so on)?

According to John Galateria, managing director with J.P. Morgan Asset Management and head of defined contribution investment solutions, the answer is both. Galateria told PLANADVISER: “There is definitely value to having an objective third party to come into an investment committee. These committees consist of people from different areas of the company (finance, benefits, human resources) and their ‘day job’ is not necessarily that of being an investment expert. Having someone come in from the outside allows them to bridge the gap between these different factions.

“There is also value in going through a checklist before contacting an investment provider and making sure you know ahead of time what objectives you want your plan’s investments to achieve. For example, how do you want to define market risk? In terms of preserving capital? Outliving your assets? The impact of inflation? You need to have investment committee members come together and put together their objectives and/or mission statement for investments first,” he added.

Seth Masters, CIO of asset allocation for AllianceBernstein and one of the white paper authors, agrees with this combination approach, telling PLANADVISER, “It depends on the plan. Some have experienced, sophisticated staff who are familiar with the issues and want to handle things themselves. Others may want to engage a consultant to partially or fully deal with the issues.”

(Cont’d…)

Participants All Invest Differently  

The white paper established that all participants have their own investment priorities and strategies, and thus all invest differently. However, the research found that there were three broad participant behavior profiles that could help in design an investment menu. These three profiles include:

 

  • Do It for Me – For participants who would like a professional to guide them;
  • Do It with Me – For participants who want to understand their plan and the risk of investments, and appreciate advice on this; and
  • Do It Myself – For participants who want to design, implement and monitor their own investment strategies.

“This ‘do it for me’ group, or delegators, make up about 80% of investors. They have no interest in becoming involved in investment decisions. They’re looking for investments, such as target-date funds, that are easy to deal with and requirement little involvement on their part. Their mind set is not based on either socio-economic standing or investment experience. The ‘do it with me’ group makes up about 15% of investors. And the last 5%, the ‘do it myself’ group, are the ones who probably read the financial press and willing to make bets on investments,” Galateria said.

Masters sees a similar breakdown. “It comes across very clearly that two-thirds of investors are of the ‘accidental’ or ‘do it for me’ type. They haven’t thought about investment decisions before and they aren’t comfortable about it. These people will on the one hand brag about what a good driver they are, but will readily admit they make poor choices about investments. The investors that are usually active and engaged can become 'do it for me' investors if they can be convinced that someone else can do it better than themselves. The smallest group is usually the 'do it myself' one, the investor that reads the business publications and always wants to be at the controls."

(Cont’d…)

Achieving the Ideal Investment Menu

Galateria said inertia can create a challenge for achieving the “ideal” investment menu.  He explained that, in the past, DC plans included only a few investments, mostly institutional ones. Then there was a move to mutual funds—the more choices the better. “But the challenge around having all those choices was that sometimes they caused confusion among participants. So in some cases, plans are offering fewer investment options now. When before they would have 25 choices, now they have 15,” he said.

“However, you still need to worry about the small group of ‘do it myself’ participants who want many options. To deal with this type of situation, many plans are now offering broad asset classes or ‘buckets’ for investments—such as stocks, bonds and cash—so that those who want more options can investment in the more-specific investments under each asset class,” Galateria noted. "Overall, participants are looking for diversification and less risk and/or volatility with their investments."

Masters believes that the definition of an "ideal" investment menu is situational. "It depends on the plan's objectives. Some plans focus on self-directed choices, offering participants many options. Other plans have a bit more of a paternalistic approach, using a simple and straightforward menu to guide their employees to a good outcome. There's no right answer for which is a better investment philosophy," he said.

The paper concludes that plan sponsors have a significant opportunity to help employees achieve a secure retirement by designing an investment menu that reflects the different levels of financial literacy and acknowledges the human behavioral biases of their employees.

The DCIIA white paper can be found here.

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