Data & Research March 19, 2014

Few RIAs Focus on Retirement Plans

New research from Fidelity Institutional Wealth Services suggests a vast majority of registered investment advisers (RIAs) are simply “accommodating” their retirement plan clients.
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Fidelity Institutional contrasts RIAs who accommodate retirement plan business with those who progressively accelerate their plan-related services and opportunities. More than nine in 10 (91%) independent advisers currently working with retirement plans do so as part of their broader wealth management practices—not as a retirement specialist, according to a survey by the Fidelity division, which provides asset custodian services for RIAs and third-party recordkeepers,.

Meg Kelleher, executive vice president and head of Fidelity Institutional’s retirement adviser and recordkeeper segment, tells PLANADVISER that accommodators typically enter the retirement planning marketplace unintentionally—often on referral from a wealth management client who happens to serve as a sponsor or fiduciary at their employer’s retirement plan. Fidelity’s research finds most of these advisers serve one to five plans and are ill-equipped to take on more.

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This presents a range of challenges for both accommodating RIAs and their clients, Fidelity explains. Many accommodators report that it is difficult to keep up with the rigorous fiduciary rules and other regulations that apply to qualified employer-sponsored retirement plans. They also struggle to build scale and grow relationships as quickly as their counterparts, who have taken time to develop specialized retirement services infrastructure and expertise.

A group of “high-performing retirement advisers” have successfully made the shift from accommodating retirement plans to accelerating their retirement business by applying a deliberate approach to growth and client relationship management, Kelleher  says. These advisers have increased their retirement plan business by 50% or more in the last five years, Fidelity finds in its research.

“Retirement planning is not an accommodators’ business for the long term,” Kelleher says. “Advisers who expect to only accommodate plans will not be able to compete with those who are dedicating real time and resources to plan clients.”

There are numerous reasons, she says, but the issue largely boils down to the fact that retirement plan services can be quite different from other services in wealth management and so require different expertise and back-office support. According to Fidelity’s research, nearly seven in 10 (67%) independent advisers who have retirement plan business report that servicing these plans is not a current focus for their firm, and in many cases the advisers said their retirement plan business amounts to “a distraction.”

For RIAs and other service providers, opportunity in the retirement planning market continues to grow, Fidelity says, and for those already involved, it is a bullish market. Fidelity finds 84% of plan sponsors relied on advisers in some capacity last year, a jump of nearly 10% from 2012. Kelleher was hesitant to predict another 10-point jump in adviser usage by retirement plans for 2014, but she feels there is very little chance that the trend will turn negative any time soon as a greater percentage of the U.S. population enters retirement.  

Kelleher says about 60% of the independent advisers identified in the high-performance group (i.e., those successfully positioning themselves as retirement specialists) anticipate their retirement business will double in the next five years. She is quick to warn firms in the accommodating group that this growth comes only through a strong focus on retirement-related expertise and service delivery. 

The research is not all bad news for accommodating RIAs, she says, as Fidelity has turned the best practices from the high-performance group into a new support program designed to help advisory firms improve their retirement services, called Retirement Plan Growth Strategies. The program is tailored for RIAs who have only a handful of retirement plan clients—or are looking to enter the space for the first time—and require a better understanding of the opportunity retirement plan clients present, as well as ways to accelerate growth in the segment through improved service.

The new program helps RIAs capitalize on the opportunity with retirement plans by demonstrating how a fee-based model, strong fiduciary experience and investing acumen can put an adviser in a unique position to grow the retirement-related part of his practice. Retirement Plan Growth Strategies features tools, insights and support to take RIAs through a three-step process that will help accelerate plan-business growth.

The first step Fidelity recommends is to determine if retirement plan clients are the right fit for an RIA firm. To help RIAs do this, the program offers a personalized approach to help advisers assess their level of interest in retirement plans and suggests resources that provide tangible next steps to begin the development process.

Next, Fidelity urges RIAs to apply a deliberate approach to growing their retirement business—not to rely on sales tools and strategies developed for wealth management or other types of financial services. Fidelity’s research found that high-performing retirement advisers dedicated more time and resources to retirement plans (55% of their time and resources, compared with 41% of time for non-specialist firms) and were much likelier to direct marketing efforts toward generating new retirement plan business (39% vs. 19% of other firms). Fidelity's research suggests these strategies can be quite powerful in winning new retirement business. 

Fidelity finds that 40% of high-performing retirement advisers say they are likely to try new ways of growing their retirement business. Once a firm is ready to begin growing their retirement plan business, making connections via clients, centers of influence and prospects are all important launching pads for growth, the firm says. Taking this into account, the Fidelity program offers advisers exclusive access to Referral-EDGE for Retirement, a prospecting tool that provides a database of high-net-worth individuals, retirement plans and centers of influence.

More on the new research and RIA support program is available here.

 

The Markets March 19, 2014

Overlay Strategy Keeps DB Investments on Target

Even the best laid plans can go off track, and this is true for defined benefit plan portfolios.
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Plan sponsors and their consultants may spend considerable time designing strategic asset-allocation strategies, but “through the course of time, due to market movements and cash flows in or out due to contributions and distributions, target allocations may get out of balance,” explains Brian Roberts, senior consultant at NEPC, LLC in Boston.

An NEPC paper written by Roberts says derivative overlay strategies offer an array of benefits, which can include securitizing idle cash, maintaining policy target exposures and managing transitions within the portfolio. An overlay solution can also help manage risk related to currency exposure, equity beta or, particularly for corporate pension plans, interest rates. In addition to maximizing the efficiency of an investment portfolio, overlay strategies also aim to keep costs low through the use of liquid and transparent derivatives that are a cheaper alternative to trading physical securities.

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Roberts explains to PLANADVISER that an overlay strategy is one for which a plan sponsor has a manager in place that oversees the overall asset allocation and makes adjustments using derivatives to keep the asset allocation at its target. For example, if the asset allocation is out of balance due to a run up of equities, an overlay manager, based on very specific, pre-determined rules agreed with the plan sponsor, using derivatives, will obtain the market exposure that is missing.

Roberts says “derivatives” is a broad term, but the primary focus of the paper is the use of exchange-traded futures. “This is the type we would anticipate most plan sponsors would employ,” he says. A futures contract is an agreement between two parties to exchange a security at a future date at an agreed upon price. But, you get that asset class exposure for only a fraction of the capital required to purchase a security.

How Does a Derivative Overlay Strategy Work?

Roberts uses the example of a long-term target allocation of 60% in the S&P 500 and 40% in the Barclays Aggregate Index that gets off balance because cash is needed on hand in preparation for paying a distribution. The asset allocation may be only 55% S&P 500/35% Barclays, with 10% in cash. An overlay manager can allocate 5% to equity and 5% to fixed income without using all the cash to get the exposure.

The paper explains that if the portfolio has $100 in cash, it may require only $5 in initial margin to get the equity exposure—leaving $95 in cash available. “Once benefits are paid to plan participants, the overlay manager can adjust the derivatives exposure to the most up-to-date cash position,” Roberts adds. “Whatever cash is there is effectively invested, not more or less. That’s an example of how an overlay manager can move quickly in and out of positions.”

Just with any investment, there is no guarantee with the derivative overlay that the portfolio will always gain. The gain or loss gets credited every day, Roberts says. Every day there is a mark to market where the buyer or seller will pay a variation margin to maintain the value of the contract. It is really about measuring over the long term how keeping cash invested will benefit the portfolio. Cash is a drag on return over time. According to the paper, based solely on the estimated historical value provided by equitizing cash and rebalancing, an overlay provider’s net benefit-to-cost ratio can be as much as 7:1.

One of the benefits of an overlay strategy specific to pension plans is interest rate hedging. This is beneficial to corporate pension plans that have adopted a liability-driven investing (LDI) framework, Roberts notes. The overlay strategy gives plan sponsors the ability to manage assets to liabilities in such a way that when interest rates move, assets in the plan move to match liabilities. There are two ways an overlay strategy can help, he says.

First, an overlay manager can monitor and maintain the interest rate hedge ratio more closely. “If you want to hedge 50% of interest rate exposure, you can do that fairly well with other investments, but market moves, etcetera, can put it off balance,” Roberts says. “An overlay manager can look at it daily to maintain the hedge ratio.” He adds that for plans that have a glide path in place, and want to increase the hedge at a certain trigger, an overlay manager can act on that intra-month at any given day. “Doing that intra-month captures spikes in the market instead of waiting until you get the month-end report and risking that the market is off again; you can capitalize on shorter-term market movements.”

The second way overlay strategies can be helpful with interest rate hedging is they help manage the hedge ratio across the yield curve. According to the paper, for LDI implementation done with fixed income strategies benchmarked to a common index, such as the Barclays Long Credit Index, there may be a mismatch in duration between assets and liabilities along the yield curve. An overlay manager can improve the effectiveness of the hedge by filling in the gaps that may exist between liabilities and assets at various points in the yield curve, that is, key rate durations, and move a plan’s target hedge ratio along a pre-determined “glide path” on any given day, thereby taking greater advantage of intra-month moves in rates and return-seeking assets.

There are things to keep in mind when selecting an overlay provider and when implementing the overlay strategy—all discussed in the paper—but, the bottom line is incorporating an overlay strategy helps maintain target allocations with greater liquidity, and for plans using LDI, the strategy helps the portfolio move along the glide path more efficiently, Roberts concludes.

The NEPC paper, “Overlay Strategies: Increasing Portfolio Efficiency Through Derivatives” is here.

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