The Markets September 17, 2014

PANC 2014: Fixed Income and Stable Value

Since the financial crisis of 2008, investment managers and retirement plan advisers have learned to be far more cautious when creating and selecting a stable value fund.
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That was the consensus of speakers on the “Fixed Income and Stable Value” panel at the 2014 PLANADVISER National Conference on Tuesday. “The market sell-off put many stable-value funds under pressure, pushing them below par to the low 90s,” said David Solomon, vice president and head of retirement services at Goldman Sachs Asset Management. On the other hand, “most of the stronger products attracted money despite the significant declines in other funds, pushing these funds to 101, 102 above par.”

Immediately following the crisis, a lot of banks and insurance companies that offered wrappers got out of that business due to the heightened sense of risk,” Solomon said. For those that remained, “guidelines got a lot stricter and durations tightened, making the products more challenging to differentiate or drive alpha. Wrap fees increased substantially.” The good news, however, is that in the past 12 to 24 months, “new wrappers have come in, there is more capacity and more liquidity in the market,” Solomon said.

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As the financial crisis erupted and “banks were tipping, clients asked us—urgently—to review wrappers,” said Robert Kieckhefer, managing partner of The Kieckhefer Group. Before 2008, the stable value funds Kieckhefer used typically had between one and three wrappers. Now, the firm looks for funds with five to eight wrappers. That is one of the key lessons learned, along with carefully “looking at the funds’ holdings to see what they are invested in. You might not like all that you find.”

For a full 22 years before 2008, Spectrum Investment Advisers used a stable value fund from a single “annuity provider. That worked well with declining interest rates,” said James Marshall, Spectrum president. Now, Spectrum uses stable value funds “with multiple insurance wrappers from a dozen different fixed-income providers.”

As to how large of an allocation an adviser should recommend that an investor assign to stable value, Spectrum manages $1.3 billion in assets, with 13% allocated to stable value. The firm also offers seven model portfolios, six of which have a small portion invested in stable value, Marshall said. Given that the current bull market is entering its seventh year, Spectrum is advising its clients to “move their position up a little bit to 15%,” he said.

Goldman Sachs recommends that its defined contribution (DC) plan investors allocate anywhere between 10% and 20% of their assets in stable value funds, Solomon said, while reminding them and their plan sponsors that “the biggest risk is demand for liquidity at an opportune time.”

Then there is duration risk, Kieckhefer said. As a result, the stable value funds that Kieckhefer recommends to clients “have maturities equivalent to a medium-term bond fund, to sustain a yield. These are not liquid investments.”

As to what duration of a put provision Goldman recommends to clients, Solomon said: “We believe in a 12-month put provision. If you want additional yield, a 24-month put might be more appropriate. You need to strike the right balance between liquidity and yield.

Kieckhefer typically recommends stable value funds to clients for safety, rather than yield. “We aren’t crazy about chasing yield in stable value. We look to fixed income for yield,” he said. That is why he is comfortable with a 2.5-year put on a stable value fund.

For retirement plans with highly paid participants that have job security, Kieckhefer might even recommend a stable value fund with a five- to six-year put. “Many stable value funds are tailored to their audience, like higher education, which tends to have a stable work force. They can go after longer durations. Others have huge cycles in their business,” he said.

To evaluate a stable fund manager, Marshall said, “there isn’t a [provider like] Morningstar to make it quick and easy.” He recommends that advisers “first, do a spreadsheet to look at duration. Next, look at the number of wrappers. Question whether the company has an adequate support team to do due diligence. Fourth, we recommend puts of 12 months or less.”

Should the economic environment begin to change to indicate a pending rise in interest rates, Kieckhefer says he recommends his clients move out of a long-duration fund into “alternatives, floating-rate funds and ultra-short bond funds.”

Marshall expects that because of the tremendous pressure the Federal Reserve is under to strike the right balance on interest rates, rates will not spike but rise slowly, which he believes will benefit stable value funds.

Kieckhefer, on the other hand, thinks that a sharp rise in interest rates is a “spring-loaded trap,” adding that now that “the economy is getting some traction, we are playing defense.”

Compliance September 17, 2014

PANC 2014: Enforcement and Litigation

Fee lawsuits pose the biggest threat to plan sponsors—and to advisers and consultants, as well. 
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This, said David Levine, principal with Groom Law Group, speaking at the “Enforcement and Litigation” session at the 2014 PLANADVISER National Conference on Tuesday, is due to retirement plan practices’ growing size—and attorneys’ pursuit of deep pockets.

“You are on their radar,” Levine said. “We all live in a land of fee disclosure now. In 2006, it was all about revenue sharing. The claims have now changed. Before, no one knew what a retirement plan’s fees were. Now, there is a focus on share classes, which ostensibly should not be retail. Think of how the government went after Al Capone. He got caught for not paying his taxes. You can get in trouble for not documenting your due diligence and your processes.”

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One of the biggest and most recent 401(k) fee litigation cases against retirement plans is Tibble v. Edison International. At the end of August, the U.S. Solicitor General filed an amicus brief asking the U.S. Supreme Court to determine whether the 9th Circuit should have decided to grant Edison the Employee Retirement Income Security Act (ERISA) six-year limitations allowance; the lower court in the original case charged the plan’s fiduciaries with failing to pursue cheaper share classes for three mutual funds, Levine noted. At the heart of this case is the court’s finding that “Edison didn’t have the due diligence on record to find another share class,” Levine said. “An open statute of limitation could drag you, as an adviser, into the process.”

Of course, Levine said, “the diligence process varies. If you are looking at the investments in a large plan, you should be looking at them quarterly. The investment policy statement [IPS] should be short, sweet and aspirational. Document why you chose a particular share class, level of investments, fund with revenue sharing and your criteria for the wash list. Fiduciary Benchmarks can be a great tool, or you can do an RFP [request for proposals], use internal resources or turn to DCIO [defined contribution investment only] providers.”

However, on top of this, retirement plan advisers do not only need to select a benchmarking process, but also must justify “how you evaluate and update your benchmarking tool, and why you use that tool,” Levine said. “Minutes from the investment committee meetings should show that you spent time and caution making these evaluations, that you considered alternatives. Using words like ‘discussed,’ ‘evaluated’ and ‘options’ are some of the strengths you can show. Don’t ever say ‘this could hurt the company’ or ‘cost the company,’” even though that may be implied.

Another major case is Tussey v. ABB Inc., in which the plaintiffs sued ABB and its recordkeeper, Fidelity, claiming that revenue-sharing payments to Fidelity breached the plan’s fiduciary duties. The District Court awarded a total of $36.9 million against ABB and Fidelity, plus $13.4 million in attorneys’ fees. The plaintiff’s attorney, Jerome Schlichter of Schlichter Bogard & Denton, has told PLANADVISER that this suggests a win is on the horizon for another pending petition, with the case citing Tussey.

“Schlicter is a controversial figure piloting many class action fee litigation suits,” Levine said. Schlicter’s firm has brought a long list of cases involving claims of excessive fees against other companies, including Krueger v. Ameriprise Financial, Gordon v. Mass Mutual, Abbott v. Lockheed Martin, Grabek v. Northrop Grumman and Spano v. Boeing. “These types of lawsuits are $20 million, $30 million, $40 million cases. These are material figures for our clients. Insurance doesn’t always cover this,” Levine said. “Many of these fee cases have been wins, but in reality the only people who win are the attorneys.”

Asked what the threshold is for assets under management (AUM) that would signal to a plan sponsor and adviser that they should seek an institutional share class, Levine joked, “I’m on tape. I’m not giving a number.” However, he continued, “Each situation is unique, and you have to approach the decision much like the selection of a target-date fund [TDF]. You have to understand the demographics of your work force. When do you move out of a mutual fund to a separately managed account or a collective investment trust [CIT]?” It’s all about vetting your decision with the right questions and “documentation, to forestall litigation,” Levine said.

Retirement plan advisers would also be wise to tactfully ask new sponsor clients how proactive they are prepared to be if the adviser finds a problem with the plan.

On the enforcement side of the equation, “it has been falsely reported that the DOL [Department of Labor] has hired thousands of litigators,” Levine said. However, “they are looking at service providers and fiduciaries like you. They have also become very sophisticated in such things as looking at revenue sharing master agreements.”

As for the redefinition of what constitutes a fiduciary, that change is not imminent, Levine said. However, advisers should keep in mind that a broadened redefinition “could make it more difficult for specialist retirement advisers to compete for business on the basis of taking on fiduciary responsibility,” he said.

Advisers should also be cautious about recommending individual retirement account (IRA) rollovers following the “inflammatory GAO [Government Accountability Office] report that used undercover callers to prove a potential bias by providers concerning rollover advice.”

The Securities and Exchange Commission (SEC) is now concentrating on auditing any firm that has been in existence for three years without an audit, Levine said. His advice to prepare for this process: “Mock audits are incredibly helpful.”

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