Finding a Good Fit
You take your client, or wife, or parents out to a nice restaurant for dinner, and want to round out the evening with some wine. There are plenty of choices on the wine list: the anonymous, all-purpose house red; a mid-price sturdy Spanish or Italian name; the exotic bottle the chef has picked to complement your meal. It’s all made from the same basic ingredient, but the extra care and finish raises the price of the top choice by a factor of five or 10. You want to pick what fits the occasion at a reasonable price.
The software for monitoring the investments in 401k plans varies in much the same way: cost, complexity, and, occasionally, snob appeal. Many are mass-produced, while others are more specialized; some are more complex than others, and cost varies accordingly. While some sponsor investment committees appreciate the refinements, others are perfectly content with more modest choices.
Client Service
Monitoring the plan investments is at the center of a plan sponsor’s fiduciary obligation and, while there are several cheap, simple services available to rate past mutual fund performance, “ERISA requires that plan sponsors go beyond the sort of analysis that you get from a basic Morningstar or Lipper review,” notes Greg Gaynier, principal at Retirement Plan Solutions, Austin, Texas, a member of the National Retirement Partners alliance. “ERISA requires sponsors to examine their plan investments as sophisticated investors would, and there’s no formula for just what measures they are supposed to use,” Gaynier adds. That creates a vacuum a plan sponsor frequently turns to an adviser to fill.
Investment evaluation is also a top business priority for the adviser, both in terms of client service and prospecting. “There’s a lot of pressure on advisers to continually demonstrate their worth to the sponsor, and justify their fees,” notes Scott Revare, chief executive at the Center for Fiduciary Management in Kansas City. His firm has developed the Fiduciary Investment Reporting Manager system, also known as FiRM, for evaluating defined contribution plan investment performance. “The most straightforward way to show you’re adding value is to help the sponsor evaluate its funds,” Revare adds. “It’s also a structured way to get in front of the sponsor at regular intervals.”
“When I’m coming in to win new business, I have to “shock and awe’ the investment committee, and one way to do that is to improve on what the existing adviser has done in investment monitoring,’ says Gaynier. Because providers’ investment offerings have become so similar, he contends, the remaining value to be added has to come from service to clients and, rather than buy software off the shelf, National Retirement Partners has developed its own package. “We want the CFO to say “wow” at our performance monitoring, and push everyone else out the door.”
How To Choose
The basic investment review, advisers say, should contain funds’ absolute and relative performance for the latest quarter and one, three, and five years; a comparison of fees relative to peers; the funds’ alpha, Sharpe ratio, and standard deviation; and portfolio turnover. More complex analyses will report on information ratios, and how the manager has added value through stock selection and asset allocation. The top tier will scrutinize funds’ individual holdings to measure adherence to style.
One could, of course, assemble investment evaluations completely on his own with little out-of-pocket cost, drawing market information from public sources, and returns from fund providers.
However, most advisers lack the time, inclination, and software chops to build and format the necessary spreadsheets and, instead, outsource the work in one form or another. The good news is that the market for performance monitoring software is well-developed and, these days, advisers have a wide choice of products and price points from which to choose.
Where should advisers draw the line on complexity and cost? That depends to some extent on how much detail the client wants, and their propensity for the investment hieroglyphics. There is a group of best-known products specifically designed for advisers to use in 401k monitoring, though they differ based on variables like cost, whether they’re delivered via the internet or software on the adviser’s computer, and the size of the adviser user base (see “Measure Me?” page 64).
All of the offerings listed in the accompanying chart allow advisers to style their presentations by laying in their own graphics and logos. EnCorr, Style Advisor, and Stylus are the richest of the offerings listed in the chart in terms of quantitative analysis. Zephyr’s Style Advisor, for instance, allows advisers to choose from 126 different statistics. The more modestly priced Fiduciary Analytics, from Fiduciary360, ranks plans on eight pre-selected criteria.
Advisers well-schooled in investment mathematics can design their own analysis that draws on more complex statistics or, if they have clients with special demands, head for the more expensive offerings. Typically, the simpler packages do not offer as much flexibility in their analysis, but they can be easier to use. “We made our system for advisers that want a report the clients can understand, is easy for the broker to use, can be customized with their own logos and graphics, and be cranked out quickly,” reports Revare.
If an adviser lacks the time to shop around—or has not already developed an affinity for a specific tool—help may be close at hand nonetheless. Advisers that sign on to a provider’s platform, such as Fidelity, SEI, or Russell Investment Group, generally receive monitoring software as part of the deal and, thus, do not need to buy their own. SEI and Russell have developed their own proprietary systems, while Fidelity has embraced the FiRM package. “We thought it was essential to have monitoring that was independent, to show that we weren’t biased toward our own funds,” notes David Liebrock, executive vice president at Fidelity Investments Institutional Services.
Aside from the statistical horsepower of the top-end products, some advisers believe that what separates these offerings is their integration of investment results with a plan’s investment policy statement. “Sponsors have to see that funds are compliant, or not, with the metrics spelled out in their investment policy statement—period, end of story,” says Jennifer Flodin, PRP, chief operating officer and co-founder of Plan Sponsor Advisors, an independent adviser in Chicago, overseeing $5 billion in assets for clients ranging from the small to the Fortune 100, that has labored to build its own system, taking return data from Morningstar, and analytics from Markov Processes Inc.
“In our reports,” she notes, “each fund has a scorecard, with 10 metrics from the sponsor’s investment policy statement, including stability of the asset manager’s organization, correlation of return and complementary asset allocation among the plan’s funds, median or better absolute and relative performance, and fees at or below the median for the fund’s peers. We review them quarterly, with supporting analytics, and present our recommendations.” She concedes that advisers with a handful of smaller plans will find it easier to outsource this sort of analysis, “and their clients probably don’t expect a real robust system.”
Whether an adviser chooses an off-the-shelf product or crafts his own, it is essential to understand how important solid reporting can be to winning and keeping clients. “We couldn’t find any firm that tied the analysis to the investment policy in the way we wanted,” Flodin explains. “By outsourcing it, we would run the risk of becoming a commodity service. Our system is an important part of our identity as a firm,” she adds. “The investment monitoring is a differentiator, and it’s what demonstrates our [investment] philosophy to our clients.”