Asset-Allocation Models

ADVISER QUESTION: We are an RIA [registered investment adviser] hired by retirement plans to provide fiduciary investment advisory services to plan committees. Our investment advisory services include developing asset-allocation models for plans. We rebalance the models on a periodic basis when they fall out of alignment with the asset-allocation portfolio’s objectives. Under what circumstances would our models be considered designated investment alternatives (DIAs) subject to the participant disclosure rules? Also, what do we need to disclose to participants?

ANSWER: The answer depends upon the design of the asset-allocation models.

The Department of Labor (DOL) states in Field Assistance Bulletin (FAB) 2012-02R that if an asset-allocation model has the following features, it will not be considered a designated investment alternative:

• If it is not unitized (i.e., the model does not have its own trading value and operate like an investment);
• If it does not use investments that are outside the plan’s lineup of DIAs;
• If it is presented to participants as an investment service that enables them to allocate among the plan’s lineup of DIAs; and
• If there is an explanation to participants about how the asset-allocation service works and how it differs from the plan’s DIAs.

If your asset-allocation models satisfy these requirements, they will not be DIAs subject to the participant disclosure rules. However, the written explanations in the third and fourth bullet points must be given to the participants.

We believe that participation communications, while not covered by the DOL guidance, must also describe the rebalancing procedure and the process by which a plan committee removes and replaces DIAs included in the asset-allocation models. Unfortunately, it is unclear in the FAB whether the rebalancing feature or the replacement of DIAs would cause a model to be a DIA. However, because those are common operational features of asset-allocation models—and the DOL did not comment negatively about them—there is an argument that they can be included in an investment allocation service (i.e., they are not DIAs).

On the other hand, if a model does not satisfy these conditions, it is a DIA. In that case, the participant disclosure rules will apply, and the plan will need to give participants—initially and annually—detailed information about the asset-allocation model, including:

• The type or category of the investment in the model (e.g., balanced fund, large-cap stock fund, etc.);
• Performance data for one-, five- and 10-year periods (or for the life of the model, if shorter);
• Name and returns of an appropriate broad-based securities market benchmark index over the one-, five- and 10-year periods;
• Total annual operating expenses of the asset-allocation model expressed as a percentage (i.e., expense ratio); and
• Total annual operating expenses of the model for a one-year period expressed as a dollar amount for a $1,000 investment.

The participant disclosures must also include a Web address that provides the model’s objectives or goals, principal strategies and risks, portfolio turnover rate, fee and expense information, and performance data—updated at least on a quarterly basis. Further, if requested by a participant, a prospectus-like document describing the model must be provided. Obviously, it would be difficult to comply with those rules without support from the plan’s recordkeeper.

When these rules were first issued, many recordkeepers did not have systems in place to capture and disclose this information for asset-allocation models. We understand that some recordkeepers are working to offer systems that satisfy these requirements for these investments.