Part Art, Part Science: Managed Account Due Diligence

A managed account program’s fees can be cut in half if it’s selected as a retirement plan’s default investment, although cost is just one of many important due diligence factors. 

A white paper recently published by the Defined Contribution Institutional Investment Association (DCIIA) provides a detailed and timely analysis of the managed account due diligence process.

The DCIIA white paper, “Managed Accounts: Due Diligence and Implementation Considerations,” is the second in an ongoing series. The new paper goes beyond the basics of managed accounts and considers how plan advisers and plan sponsors can work together to determine whether a given managed account provider is a good fit. According to the paper, the answer to this question should be based on a handful of key factors, which include the quality of the participant experience, the soundness of the investment methodology, the operational details and risk controls, the net fees, and the ability to track success benchmarks.

Beyond these areas, DCIIA says, it is critical to develop a clear understanding of a plan’s broader goals and objectives—for example whether it is meant to be used as a lifelong retirement spending vehicle or simply to get people to their retirement date with the greatest amount of wealth possible.

Engagement Is King

According to DCIIA, plan fiduciaries should understand that a managed account program’s value often hinges on participant awareness and engagement, particularly when the managed account is not the default investment option. But, arguably, if a managed account is chosen as the default investment, this heightens the importance of the engagement factor even more.

“Currently, recordkeepers have basic participant demographic information—such as age, income, savings rate, plan balance and gender—and some or all of these may be directly shared with the managed account provider,” the paper explains. “Participants can also directly supply the managed account provider with additional personal details, such as their risk tolerance, potential or desired retirement age, and savings and investments outside the retirement plan.”

DCIIA says a user-friendly interface can encourage participants to provide these personal details, leading to more individualized recommendations. However, if a participant fails to provide this additional information, the managed account provider must set an asset allocation and manage the investments using the recordkeeper’s data.

“Most managed account providers offer an array of engagement tools, along with a subset of implementation guidelines for each tool,” DCIIA reports. “Often, the managed account provider has communication materials that the recordkeeper and plan sponsor can leverage. These materials can be targeted to specific groups or, in some cases, customized to specific participants.”

The better the managed account providers’ engagement resources, the more effective the solution is likely to be. At this stage, DCIIA says, sophisticated and multi-channel approaches to engagement are fairly common across managed account providers. Advisers and sponsors should work together to determine that all user interfaces are intuitive and actionable. DCIIA suggests there should also be a capability for the participant to share information with their in-plan or outside adviser, if applicable.

“The sponsor should also determine and evaluate the way(s) in which a managed account provider reports to a sponsor about their communications’ effectiveness and participant engagement,” the paper proposes. “For example, some providers might track participant engagement across their programs and report on items such as the click-through rate and the percentage of participants taking action.”

Investment and Process Considerations

DCIIA’s survey of the managed account market finds providers today generally create portfolios using a defined contribution (DC) plan’s core menu options. For this reason, the robustness of the core menu will have a significant impact on a managed account’s effectiveness, and it must be taken into consideration during the due diligence process.

“Plan sponsors should understand the provider’s philosophy around using the existing investment options in the core menu,” the paper says. “Managed account providers typically prefer more investment options to fewer, since greater variety provides them with more flexibility in building diversified portfolios. In addition, managed account providers look at the available funds from risk and correlation perspectives.”

DCIIA says plan sponsors wanting to maintain a streamlined core investment menu might want to consider providers that can build participant portfolios using investments available only in the managed account.

“This can allow for increased diversification while avoiding more esoteric fund offerings in the core menu that may not be widely utilized, or utilized incorrectly, by participants,” the paper explains. “Plan sponsors should note that fiduciary oversight of this arrangement may be different from that of the rest of the plan, as they may now have new types of asset classes around which they need to perform due diligence.”

An important issue pointed out in the paper is that, for a plan sponsor to select a given managed account provider, the recordkeeper must be willing and able to accommodate said provider. If a plan sponsor’s preferred managed account provider is not already available on the plan’s recordkeeping platform, the plan could consider changing recordkeepers or working with the recordkeeper to add the preferred provider to the platform. DCIIA says neither of these approaches represents “an inexpensive proposition.”

Though the DC industry is looking at data exchange protocols to simplify access to multiple providers for a given recordkeeper, DCIIA says, this has not yet come to market and is likely still some ways off.

Managed Account Risks and Fiduciary Monitoring

Given the increase in cybersecurity incidents in the financial services industry, DCIIA’s analysis encourages retirement plan fiduciaries to specifically assess managed account providers’ policies and procedures for mitigating such risks.

“Investment risk is often addressed within the investment methodology, but plan sponsors can probe further on mitigation tactics, scenario analysis and use of specific software,” DCIIA says. “Due to the increasing number of cybersecurity breaches, plan sponsors should inquire about how the managed account provider handles data processing and security. In addition to understanding the provider’s privacy policies and procedures, plan sponsors should find out if any third parties might have access to participants’ private information.”

DCIIA says understanding privacy and data-sharing practices can also help uncover risks posed by conflicts of interest, such as when a managed provider would benefit from using this information to cross-sell retail products. This is especially important for plans governed by the Employee Retirement Income Security Act (ERISA). Many qualified ERISA plans have been sued for, among other issues, permitting providers to conduct cross-selling based on what plaintiffs’ attorneys argue is private and protected information.

Finally, Fee Issues 

As with any service provider, plans must consider and evaluate the managed account provider’s fees in the context of the services provided and expected benefits, DCIIA says. The analysis says a fee monitoring process should include collecting information from prospective providers about all of the following areas:

  • How are the fees stated—in terms of basis points, or another method?
  • Are the fees paid by the participants and, if so, how are they disclosed to participants?
  • According to the managed account provider, how does it add value to the plan?
  • Do fees vary depending on whether the managed account is the default option or one that requires participants to opt-in?

DCIIA says the last point is especially important, given the potential for significantly reduced costs if a managed account provider serves as the default. According to the analysis, a managed account program that would cost 45 to 60 basis points (bps) as an opt-in option could be reduced to 20 to 35 basis points, if it is selected as a plan’s default investment.

“Plan sponsors should determine if the value that participants will receive from a managed account program is worth these additional fees,” the analysis concludes. “In order to do so, sponsors should carefully decide what ‘value’ means in their plan. For their part, managed account providers may seek to address this question by quantitatively analyzing a plan’s participant base; providing personalized participant-profile examples; or showcasing how retirement readiness changes over time. Each approach comes with particular assumptions, caveats and disclosures, which should be taken into consideration when reviewing providers.”

The white paper draws the conclusion that managed accounts can be a useful program to improve participant retirement readiness.

“As with any plan product or service, fiduciaries should conduct due diligence or consult with outside experts to determine which service provider would work in the best interest of plan participants,” the paper says. “Sponsors should also be prepared for the complexities involved in evaluating and monitoring managed accounts, since they require different oversight than other investment products and services do.”

Plan advisers and their sponsor clients can find a sample request for proposals (RFP) in the appendix of the DCIIA white paper that’s designed to help fiduciaries address all the questions raised above.