Investment Committee Training
Retirement plan investment committee members must make important investment menu decisions that seriously influence plan outcomes. These fiduciaries are responsible for defining and following a process of plan administration—likely articulated in an investment policy statement (IPS)—that establishes a prudent framework they then use to regularly evaluate investment fund performance and service provider fees. Therefore, training committee members is a critical function of defined contribution (DC) retirement plan advisers.
Stray from the fiduciary framework, and both the adviser and committee members can face significant liability under expanding fiduciary rules and the Employee Retirement Income Security Act (ERISA).
All of this puts a heavy administrative burden on investment committee members, explains Jake Gilliam, a managing director and senior portfolio manager at Charles Schwab Investment Management in Richfield, Ohio. That means advisers must provide high levels of committee education and support to ensure quality plan outcomes, he says.
Investment committee education begins by offering “relevant education, and breaking it down so that it becomes part of the decisionmaking process,” says Phyllis Klein, senior director of the consulting research group at CAPTRUST Financial Advisors in Raleigh, North Carolina. CAPTRUST’s training topics include: What makes someone a fiduciary; the duties of a fiduciary (prudence, loyalty, avoiding prohibited transactions, diversification, monitoring and supervision); and Department of Labor (DOL) enforcement policies and trends.
When onboarding new members, CAPTRUST either holds a training recap with the entire committee or a one-on-one meeting or webcast with a new committee member, Klein says.
Like the average plan participant, investment committee members tend to be busy people, with a host of daily job duties that may have nothing to do with the retirement plan, Gilliam says. So, simply increasing the volume of investment committee education is not necessarily an effective way for advisers to drive improvements in plan outcomes, he says. As can happen with the plan participants they serve, committee members can actually grow less engaged when things get overly complicated.
Where does this leave advisers, who must juggle their own operational efficiency and staffing considerations when planning investment committee training programs? Experts say it depends on the particular service model and the extent to which the adviser assumes discretion over plan investments.
An adviser who takes on significant fiduciary liability under a 3(38) discretionary investment management arrangement, for instance, will need to establish a different relationship with the committee than a limited-scope, 3(21) adviser who provides more restricted, fee-based investment advice to individual participants. As the 3(38) adviser bears more discretion over participant dollars, the committee’s day-to-day role may not be as important, whereas the 3(21) adviser leaves more discretion for plan investments to the committee, so he must ensure it is well-equipped to make the right decisions day in and day out.
A Rigorous IPS
A good place for most advisers to start improving the performance of the investment committee is to ensure the IPS is smartly crafted, that the rules it stipulates are followed closely by the plan committee and that the members understand its goals, says Brad Thompson, chief investment officer (CIO) for Stadion Money Management, in Watkinsville, Georgia. Advisers should not take it for granted that the processes spelled out in the IPS are understood or closely adhered to by the committee, he cautions.
Additionally, it is important to acknowledge the committee members’ fiduciary status in writing and ensure they understand both their corporate and personal liability, Thompson says. On an annual basis, the adviser could provide legislative and regulatory updates to inform clients of the evolving regulatory landscape, especially as new fiduciary rules are expected from the DOL and other federal and self-regulatory bodies.
“One common issue we see is that plan committees have had a tendency to just adopt a boilerplate or off-the-shelf IPS, which typically says little about the types of investments the committee is actually looking at,” Thompson says.
Additionally, many investment policy statements are built exclusively around the idea of passive investments, which for a long time served as the investment vehicles of choice in the 401(k) and defined contribution plan space, Thompson notes. Index-based investments are still an important part of retirement portfolios, he says, but a modernized investment committee must be equipped with tools to research, adopt and monitor a wide diversity of investments, not just equity funds. What does the committee know about the evaluation of exchange-traded funds (ETFs), for instance? What about real estate holdings and other illiquid exposures provided through liquid alternative mutual funds? These are subjects an adviser should help committee members understand.
Thompson and others say advisers should also contemplate ways to bring data visualization tools to investment committees to help them consider the demographics of their plan’s participant population. These tools automatically collect and aggregate participant recordkeeping data into easy-to-digest reports on a wide range of plan characteristics. The plan’s age ranges can be used, for example, to better understand what the plan’s overall risk tolerance may be, and therefore what funds the committee should offer.
“Advisers need to help the sponsor and the committee think about these ideas and see how they can be built into the investment policy itself, and ultimately the investment menu,” he says.
Recent trends have widened the defined contribution investment universe to include more prepackaged, actively managed fund-of-fund options, such as target-date funds (TDFs), Gilliam says. The adviser and committee thus need to carefully disclose the underlying funds of the TDF or any other prepackaged product, and note whether each has a satisfactory track record and whether it is proprietary or third-party, he says.
The IPS should also be tailored to address governance problems that can emerge in the fund-of-funds space, especially as TDFs become the most common qualified default investment alternative (QDIA) option.
“We commonly see target-date funds that are using underlying holdings in basically untested or underperforming proprietary funds—funds that wouldn’t pass muster to be included on the core investment menu as a standalone fund,” Gilliam says. “How is the committee going to watch for this effect? You can see how it could be a problem to include a TDF option that itself passes the IPS standards but for which the underlying holdings do not.”
In addition, a robust IPS should describe what puts an active manager on a watch list and what will lead to the termination of a manager or fund option, Gilliam adds. Fees can range widely for comparable services, and labeling can be a challenge among actively managed, prepackaged offerings, Thomson says. This means investment committees’ evaluation skills must be updated.
“We see that it’s really necessary in this investment climate to add things such as alternatives and downside strategies and other ways to bring the proper diversification and non-correlation to participant portfolios,” Thompson says. “Those require a totally different type of monitoring process than the passive, index-based investments committee members have so far been trained to understand, so it can be a big opportunity for the adviser to train the committee on these processes.
“The investment committee also needs to consider the demographics of its plan participant population and think about how many bear markets these participants are going to have to go through,” Thompson continues. “Historically, they occur about every five years,” so it is important to consider the downside and the protection of conservative offerings over the life of the portfolio.
Advisers need to address the individualized risks each participant faces, Gilliam agrees. That means discussing appropriate asset allocations for participants, which may require personalized goal-setting to further match growth needs against the markets and longevity.
Gilliam says advisers can teach the committee about the various forms of risk and how each applies to a fund or investment strategy—from income shortfall risk, to interest-rate risk, to sequence-of-return risk. The committee should be well-versed in them all, he says.
According to Thompson, when examining the performance of tactical asset managers and active management equity funds, advisers should make sure committee members have access to performance data presented and analyzed over full market cycles, so they can see the strategy unfold on the appropriate time scale. For index-based investments with a close benchmark tracking error, it is easier to look at widely published quarterly data and get the whole performance picture.
An investment committee may be uncomfortable spelling out these processes in the IPS, for fear of promising too much or inviting unintended liability, he says, but in that case the adviser should consider developing informal process documents to assist committee members as they evaluate and monitor other types of funds.
“As these increasingly complex and active funds gain prevalence, the investment committees have to adapt to doing things differently. It can be a big value-add for the adviser to teach this kind of evaluation,” Thompson observes.
Tailored to the Plan
Moving beyond the IPS, Gilliam and Thompson say advisers should ensure the committee is considering the way participant demographics shape plan performance. There is an important step between the inclusion of a fund on the investment menu and its impact on plan outcomes, Gilliam says. Even the best fund in the world requires participant buy-in to work.
“Those conversations with the committee do get pretty nuanced, because oftentimes there are representatives from human resources [HR], operations, legal and compliance, sometimes a representative from the employee base, and then the plan sponsor and the treasurer and the CFO [chief financial officer]—they’re all at the table while we’re evaluating funds,” Gilliam says. “Advisers should be ready to answer the questions from HR about what type of education may be provided, [or] what customized pieces [they] can build for participants. Everyone has a different demographic base, and they want the service to reflect that.”
Gilliam and Thompson concur that the right tools can help an adviser strike a manageable path forward when it comes to the training and ongoing support of the investment committee.
“We still want to preserve the simplicity of the decision for the participants and the committee as much as possible,” Gilliam says. “At the end of the day, [committee members] want to help their employees save for retirement, but they don’t want to be full-time asset managers. That’s where the adviser can really step in and deliver.”