The Markets December 11, 2014

Managed Account Services Growing More Complicated

The biggest challenge for retirement plans offering managed account services to participants is creating simplicity out of increasing complexity, says Cerulli Associates.
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Research from financial analytics firm Cerulli Associates finds managed account providers are fielding an increasing number of questions and information requests from clients, stemming mainly from the growing size and complexity of managed accounts as a product category.

Tom O’Shea, associate director at Cerulli, explains that managed accounts once comprised only a handful of investment types, including mutual funds, individual securities, and sub-advised accounts. Today, providers are adding exchange-traded funds (ETFs), liquid alternatives, model-driven portfolios, and other options to the mix.

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Besides the proliferation of investment vehicles, the growth of rep-as-portfolio-manager (RPM) programs has added another layer of intricacy, O’Shea continues. Through RPM programs, financial advisers are re-asserting their role as the client’s adviser on asset allocation, rebalancing, and security selection, he notes. 

Cerulli suggests the rise of RPM and new managed account vehicles has placed a tremendous operational burden on managed account providers. As O’Shea explains, providers will need to update antiquated technology platforms that were built for a simpler time when the number of managed account options was far smaller, to keep up with demand.

The findings are from Cerulli’s fourth quarter 2014 issue of “The Cerulli Edge – Managed Accounts Edition,” which explores a number of questions ranging from the state of tax management in RPM programs to the biggest challenges presented by managed accounts.

The analysis finds that prior to the market downfall of 2008, financial advisers tended to delegate asset allocation, rebalancing and security selection for clients' managed accounts either to dedicated home-office teams or independent sub-advisers. As the markets declined, however, Cerulli says clients increasingly pushed their advisers to re-allocate their portfolios quickly, in some cases requesting total liquidation. Having relinquished so many aspects of portfolio construction to others, advisers found themselves incapable of nimbly responding to their clients’ demands.

Cerulli says the growth of RPM programs manifests advisers’ desire to take back control of client accounts and assure that, in the future, they can more quickly accede to client requests. But while the assertion of control may help advisers better react to future client demands, it also complicates relationships established prior to 2008, when advisers, providers, portfolio managers, and sub-advisers settled on a clear division of responsibilities in portfolio construction. And, as Cerulli notes in its report, RPM programs can seriously challenge the efficiency and scalability of an adviser's business model.

In an effort to protect market influence, portfolio managers and managed account providers are pioneering ways of helping advisers minimize the tax consequences of transitioning accounts from one sub-adviser to another, Cerulli says. Despite these advances, advisers need additional training on using all the techniques of tax-savvy investing throughout the entire calendar year.

Cerulli warns the rise of RPM and new managed account vehicles has placed a tremendous operational burden on existing technology platforms in the industry. However, developing revised platforms can be so expensive and time-consuming that only the largest firms, with the most extensive information technology resources, appear to be able to manage the project in-house. Most other firms will have to outsource their efforts to platform vendors that specialize in the intricacies of the managed account business, Cerulli finds.

Information about how to purchase this and other Cerulli reports is available here.

Compliance December 11, 2014

Industry Groups Urge No Further Rules for Brokerage Windows

Responding to a request for information from the DOL, most industry groups said they believe no further regulation is necessary to govern use of brokerage windows in retirement plans.
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Retirement industry groups responding to a request for information (RFI) from the Department of Labor (DOL) about the necessity of definition and disclosure regulations about brokerage windows were mostly against such guidance.

As summed up in a letter from the Insured Retirement Institute (IRI), relatively few plan sponsors actually include brokerage windows in their plans, and among plans that offer brokerage windows, an extremely small percentage of participants in those plans actually use the brokerage window. The majority of participants who invest through brokerage windows are typically highly compensated senior executives with sizable account balances, a group that tends to be sophisticated investors for whom additional regulatory protections are not needed.

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The IRI suggested, as did other industry groups, imposing additional regulatory burdens with respect to brokerage windows would likely cause plan sponsors to cease offering them, which could adversely impact plan participants in one of several ways:

  • Some plan sponsors would replace the brokerage window with a larger and more complex menu of investment options in order to accommodate sophisticated investors who want more choices, which would make it more difficult for average participants to choose appropriate investments;
  • Some plan sponsors may opt to eliminate the brokerage window from their plan, depriving participants of access to a wider variety of investment options;
  • Small sponsors might cease offering their plans entirely, and would be less likely to initiate new ones.

Most commenters said they are not aware of any reported abuses or concerns involving brokerage windows that would necessitate additional regulations.

In its response, the Securities Industry and Financial Markets Association (SIFMA) said it believes the DOL has already addressed any ambiguity surrounding what constitutes a brokerage window or similar arrangement through its clarification of what constitutes a “designated investment alternative” in Q&A 39 of Field Assistance Bulletin 2012-02R. In that Q&A, answering the question of whether a brokerage window or similar arrangement (with respect to which a fiduciary did not designate any of the funds on a platform) constitutes a “designated investment alternative,” the DOL answered “no.” The regulator said explaining that “[w]hether an investment alternative is a ‘designated investment alternative’ (DIA) for purposes of the regulation depends on whether it is specifically identified as available under the plan.”

In the same answer, the DOL also made clear that, with respect to brokerage windows and similar arrangements, fiduciaries of the plan are still bound by “ERISA section 404(a)’s statutory duties of prudence and loyalty to participants and beneficiaries . . . including taking into account the nature and quality of services provided in connection with the platform or brokerage window.” 

SIFMA said it believes the guidance provided by the DOL to date is sufficient to ensure a fully informed and prudent process for making determinations associated with implementing and offering a brokerage window as part of a retirement plan.

The Investment Company Institute (ICI) also said it feels prior DOL guidance is sufficient. It noted that, “The Department’s historical practice of excluding investments held in brokerage windows from the status as DIAs [designated investment alternatives] is both understandable and appropriate given the attendant obligations and exposure inherent in such a characterization.” The ICI said compliance with the obligations of a DIA, including disclosure requirements, for each investment offered through a brokerage window would be virtually impossible and would overwhelm plan participants. 

There were some commenters that believe additional regulations about brokerage windows could be helpful. Among those was Russell Investments, which said rules for DIAs and brokerage windows should be very distinct and fiduciaries do not always understand what is expected of them with regards to brokerage windows.

For example, Russell suggested guidance about:

  • What should be considered a brokerage window and what should be considered a DIA;
  • The circumstances in which it is prudent to offer a brokerage window, and the circumstances in which it is not;
  • Conditions that must be met within a brokerage window, including disclosure requirements;
  • Necessary steps to ensure that those who use a brokerage window are aware that there is a different level of fiduciary responsibility for the plan sponsor with regard to those investments; and
  • What data ought to be gathered to monitor the brokerage window, and the purpose for which that data should be applied.

The National Association of Plan Advisors (NAPA) suggested the DOL establish a small-plan exception for brokerage window-only plans. To encourage small employers to sponsor defined contribution plans, NAPA said, employers with 99 or fewer employees eligible to participate in the plan should be allowed to open brokerage window-only plans, so long as each participant positively elects his or her investment choices on the brokerage window account application form. If a participant fails to make such an election, no contributions can be made to the plan on the participant’s behalf until the election is made.

In addition, NAPA suggested fiduciaries of retirement plans with 100 or more eligible employees must designate a core menu of investment options before an brokerage window can be offered to participants and beneficiaries. It also urged the DOL to continue to permit aggregate reporting of plan assets held in brokerage window accounts under the “other” category of Schedule H of the Form 5500. “The degree to which plan recordkeeping systems are integrated with brokerage account systems varies widely. A mandate to report … investments by asset category would drive up costs with little real benefit to participants,” NAPA said.

Responses to the DOL’s request for information about brokerage windows can be accessed here.

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