DISRUPTION: 3(38) Market Leader CAPTRUST Talks Growth Trends

“If the whole DC plan advisory industry could have a do-over from say, 20 years ago, I think there would probably be much more of an emphasis from a lot of different firms on the 3(38) arrangement,” says CAPTRUST CEO Fielding Miller; in an exclusive interview, he describes in detail the firm's success building scale in the 3(38) fiduciary advice market.

Sitting down for the latest in a series of broad retirement industry strategy discussions with PLANADVISER, Fielding Miller, CEO and co-founder of CAPTRUST, said his firm is in the midst of “a real push on 3(38) fiduciary services.”

“Recently, the business model has clearly been evolving in favor of greater use of 3(38) fiduciary arrangements,” Miller said. “In today’s environment, the arrangement makes a lot of sense for a lot of different clients, we feel. It makes a ton of sense on the smaller end of the market, and, in fact, it’s one of the few ways you can try to scale an advisory solution for that otherwise-tricky marketplace.”

Miller observed that the 3(38) fiduciary relationship, compared with the 3(21) fiduciary relationship, requires less touching on the part of the adviser. “You’re still managing the money and doing your job as an adviser,” he noted, “but you don’t have to wait for the committee meetings to effect a given fund change, for example. So, in that sense, it can be a lot easier to build scale based on 3(38) relationships.”

As one looks at retirement plans that have greater amounts of assets, Miller said, the committee structure is more entrenched, which has slowed the uptake of 3(38) services relative to 3(21) services. Under the 3(21) arrangement, as readers likely know, the plan committee receives fiduciary advice but retains the final discretion and responsibility for enacting that advice—or for ignoring it.

“Many mid-sized and larger plans have managed fund menus with the committee structure and 3(21) advice for 20 or 30 years or longer, and that’s how they feel that they like to do it,” Miller observed. “To turn the management over to a 3(38) fiduciary adviser, in the eyes of these folks, can be tricky. On the other hand, we find the most interest in 3(38) at this point when we are going into a new plan sponsor that has not worked with a specialist adviser before, and we can hold up 3(21) and 3(38) arrangements side by side.”

A lot of the time, the small plans will select 3(38), Miller said, even with the roughly 35% premium on that offering over the 3(21) offering. “That’s about what the premium averages these days for our clients, and many of them are happy to pay that for the additional value they receive,” Miller said.

Opportunities and hurdles to growth

Of course, the 3(38) arrangement has its hurdles from the advisory firm growth perspective.

“It is pretty intuitive why 3(38) seems more scalable—because you can create your investing models and manage them directly on behalf of many clients all at once,” Miller explained. “However, if you zoom in and think about how trading and processing works in 401(k) plans, you can see that the benefits of this scale will only come into play once you reach a certain amount of back office sophistication and client volume.”

The idea is that, because each retirement plan provider has a different set of rules for trading and processing, the adviser taking on 3(38) services simply must have a strong back office operation to create the whole 3(38) architecture that will allow more efficiency by creating the opportunity to make bulk omnibus trades.

“So it’s not a complete net savings, in other words,” Miller said. “You have to do all that difficult work in advance of creating these systems and negotiating with providers to make it as efficient and cost-effective as you can. But this challenge is surmountable, and more and more we are having success leading with 3(38) as our recommendation for many new clients. We do think it’s the right way to go for a lot of folks.”

Part of the reason why he feels good making this argument is that the firm has had real success with the challenges just cited—and CAPTRUST, Miller said, has designed and negotiated effectively all the rules of engagement with the various providers its clients use.

“As an example, say we have a set of clients utilizing investment menus built around Fidelity products—on our system all of the clients using Fidelity products are processed and treated the same, and so we can at the end of each day enact omnibus trades,” Miller explained. “This is where the efficiency of 3(38) can come in. If we want to change fund X to fund Y, it is one set of instructions we have to give to Fidelity and they will enact this for, say, 30 or 40 plans all at once.”

The program is referred to internally at CAPTRUST as “Provider Link.” Without this infrastructure in place, the firm would have to go to each plan sponsor and get the proper documentation for each trade, very quickly drying up the potential efficiency of the 3(38) approach. 

“This effort to create more omnibus trading has really paid off for our clients. It’s a neat thing that the industry may follow, we believe,” Miller said. “We’re up to using this with six major providers, and it’s had a big impact. There was a PIMCO study that came out in 2017 that added up all the 3(38) assets of advisory firms, and we were shown to have roughly 70% of market share. I’ll be completely frank. We are very proud of our offering, but the main reason this is true is that we got started earlier than most everyone else—and we have this infrastructure in place.”

The broader growth picture

Miller also commented on the dozens of acquisitions the firm has conducted in the last decade under his watch, suggesting the momentum is sure to continue.

“CAPTRUST has to compete against a lot of other buyers of advisory practices in todays’ market,” Miller observed. “Part of what helps us stand out is that we are entirely employee-owned, and we have no outside capital invested in the business. Oftentimes, this fact has served as an important differentiator in the eyes of potential independent advisory firm prospects, which can be somewhat wary of merging into venture capital ownership.”

Another factor that has buoyed CAPTRUST’s acquisition efforts is the strong 15% annualized growth rate of firms that have been acquired in the last decade. As Miller explained, generally speaking a firm joining the CAPTRUST network can expect to double its gross organic growth capacity, “and no small part of this is the fact that we target firms that have a compatible match with our culture and our beliefs about where the retirement plan and investment business is heading.”

On Miller’s analysis, the expansion in growth capacity comes in large part because firms joining CAPTRUST gain robust back-office support during the request for proposal process. Broadly speaking, Miller said, far more plans are utilizing full-fledged RFPs when seeking out a new advice provider—and indeed when seeking out all the different types of plan service providers.

“The small- and micro-plan marketplace is slowly but surely starting to really embrace this as well, and so the market is rationalizing and becoming ever more competitive,” Miller noted. “Being able to shine in the RFP process is absolutely vital, and smaller independent shops can have an issue dealing with this, just given their resource constraints.”

It also helps, the fact that the Department of Labor (DOL) fiduciary rule is pressuring advisers to ramp up their already-significant compliance efforts, which can understandably be harder for smaller firms with less resources to spare.

“All in all, it remains an appealing time for practices to think about how to boost scale,” Miller concludes.