Leading the Way

A 401(k) plan’s investment committee is charged with tremendous responsibility—to create an investment policy statement, select offerings in the plan, monitor vendors, check fees and act as a fiduciary. Advisers to 401(k) plans typically sit in on each investment committee meeting—in person or, at the least, via teleconference. Therefore, those committees with access to a retirement plan adviser or consultant rely heavily on them for guidance and education about investment choices, defined contribution (DC) plan trends, market developments and participant behavior.

Although no two investment committees are the same, they all can benefit from following certain best practices. 

Here are six steps an adviser should take to adroitly and expertly lead an investment committee.

1) Establish committee parameters. Advisers and consultants agree that the first key to a successful investment committee is setting policies and controls. 

“What protects the investment committee is a strong fiduciary process that keeps the investor’s interests at heart,” says Toni Brown, director of U.S. client consulting for Mercer Investment Consulting in San Francisco. Thus, she says, the investment committee must set its own rules and membership bylaws, meet at least quarterly, and keep detailed minutes and records of all discussions and documents referred to during its meetings. Although quarterly meetings are often considered a best practice, not all plans find time to do a formal review on that schedule. The most frequent review of investment options is annual, cited by 33.6% of plan sponsors responding to the 2011 PLANSPONSOR DC Survey, with almost as many (32.9%) reviewing their plans’ investments quarterly.

The committee typically has four to six members—though they need not all be employees. Although 43.7% of companies say their investment committees comprise employees only, 36.6% say nonemployees are also members, according to the 2011 PLANSPONSOR DC Survey. Employee-only committee members might include senior members of the human resources, finance, legal, operations and executive teams. In companies with fewer than 1,000 employees, it is not uncommon for the investment committee to include top executives, including the chief financial officer, chief operating officer, general counsel or chief compliance officer and even the CEO. If bringing in nonemployees, then advisers, consultants, attorneys or even third-party administrators (TPAs) might be asked to become members.

A financial background is unnecessary for membership, but each member of a 401(k) plan’s investment committee must be knowledgeable about Employee Retirement Income Security Act (ERISA) and fiduciary fundamentals, Brown notes. Therefore, education about ERISA, guidance on making and closely monitoring investment choices, as well as insight on 401(k) trends, developments and regulations are where the adviser comes in.

“Advisers should understand investment and defined contribution trends and be able to communicate issues that have come up in lawsuits, to help plan sponsors avoid problems,” Brown says.

“You have to ensure that investment committee members are educated,” echoes Carmella L. Elco, president of Resources for Retirement in Yardley, Pennsylvania. “That is what makes my job challenging. You have to take complex things and simplify them, without using industry jargon.”

Although some of the members of the investment committees Elco works with are financial experts, most are not. To make these executives feel comfortable with the topics and issues at hand, Elco offers them one-on-one consultations.

This is a two-way street that benefits Elco’s practice, as well. By attending investment committee meetings and conducting personal tutorials, she gleans key information about her clients—most notably, their challenges and goals. “This all goes back to knowing your committee, what is important to them and how to interact with them,” Elco says.

With an investment committee, especially, Elco counsels advisers to “understand the group dynamics and how to satisfy each person’s decisionmaking ability.” Working with the investment committee, the adviser should also ensure that a plan has the appropriate experts—including an ERISA attorney, custodian and recordkeeper—information, data and tools in place to oversee the plan. The two key sources of data fall into two categories: participant activity and fund data, says Josh Cohen, Russell Investments defined contribution practice leader for Americas Institutional, based in Chicago. “The first part is monitoring plan participant activity, which comes from the recordkeeper” and consists of information such as “participation rates, savings rates and asset allocation,” Cohen says.

2) Create an investment policy statement. 

The most critical document for the 401(k) plan’s investment committee is a written investment policy statement (IPS), which can be revisited and updated as needed. While ERISA does not require an IPS, retirement plan experts agree that devising such a formalized road map is a judicious move.

In fact, the 2011 Deloitte Consulting Annual 401(k) Benchmarking Survey found that 91% of plans have a formal investment policy statement, with 96% reviewing and/or updating it within the past three years. Nearly three-quarters (71%) have reviewed it within the past year.

“Typically, over the past five or 10 years, you only saw defined benefit plans with investment policy statements,” says David C. Kaleda, a partner in Alston & Bird’s Employee Benefits & Executive Compensation group in Washington, D.C. Following the market downturn of 2008 and the ensuing market volatility, however, defined contribution plan sponsors began to realize that simply assembling a lineup of mutual funds or other professionally managed options is insufficient to create and monitor a sound plan, Kaleda says.

The investment committees that Alston & Bird advises are meeting more regularly and very deliberately parsing through details such as the cost of insurance wrappers on stable value funds or securities lending in collective trusts, he continues.

So, what kind of guidance and parameters do investment policy statements offer to investment committees to help them more effectively do their jobs?

An investment policy statement typically begins by explaining that the plan is open to all employees, according to the white paper “Best Practices for Investment Committee Members,” from Miami-based  registered investment adviser (RIA), Brightscape. Furthermore, the paper says, an IPS affirms that the plan’s investment funds will be prudently selected and monitored in accordance with Department of Labor (DOL) ERISA laws. Therefore, the IPS expressly states that the investment committee is entrusted with complete due diligence in selecting and retaining professional investment managers, in addition to consultants, custodians, attorneys and accountants.

“ERISA doesn’t require you to pick funds that are stellar,” Kaleda says. “What ERISA really is about is procedural prudence.”

Additionally, the IPS expressly states that the investment committee will continue to monitor each fund’s performance against its peers’ and its benchmark. In fact, the IPS should lay out a series of criteria that each fund in the plan should meet every quarter, such as: style consistency, performance in the top quartile, a minimum two-year track record and a trading volume of at least 10,000 shares a day. Should a fund fail to meet such criteria, or be subject to a change in portfolio managers or investment objective, for instance, the investment committee would then place funds on watch and consult with their plan adviser regarding whether to remove the funds.

Thus, the IPS will clearly define when a fund should be rejected from a plan and what course of action the investment committee should take to replace it.

The IPS also documents, in accordance with the diversification requirements of ERISA Section 404(c), that the plan will offer at least three core investments from a balanced selection of equity, fixed-income, ­cash-equivalent and, recently joining the options, alternative funds. The aim is to offer a variety of prudent options from which participants can create a portfolio to meet their individual risk tolerance and goals. The IPS notes, too, whether it will employ automatic enrollment/step-up, and, if so, what the options and criteria are for the plan’s qualified default investment alternative (QDIA).

The IPS also states that the investment committee will vet and monitor Investment Company Act of 1940-registered investment firms whose products it selects for the plan and ensure that these investment companies are in good standing with regulators and clients, with no material pending or past legal actions against them. The IPS typically says, as well, that the investment committee requires each investment company in the plan to provide detailed information about the history of the firm, its investment philosophy and approach, principals, clients, locations and fees.

As far as the fees for the investment advisers, recordkeeper and plan administrator are concerned, the IPS should spell out procedures to account for and control plan investment and administrative expenses.

“Fees are one item that have been taking up a lot of time, because of the recent regulations,” Elco says. Understanding and comparing commissions and revenue-sharing fees is particularly challenging since “vendors have different ways of collecting fees,” depending on whether the investment offering is an insurance product or mutual fund, Elco explains.

Another critical topic covered in most investment policy statements is investment education for participants.

The IPS typically says individuals are responsible for making their own investment decisions in the plan, and, therefore, the sponsor will equip participants with information about the choices available to them, including fund prospectuses, annual reports and semiannual reports.

Additionally, the plan sponsor will enable participants to make investment decisions at least quarterly.

3) Understand the fiduciary burden. 

By supervising the investment policy statement and putting it into practice, the investment committee members generally meet the five-part test to become plan fiduciaries.

“Half the time, the people on the investment committee do not know they are a fiduciary,” says Greg Kasten, MD, CEO of Unified Trust Co. in Lexington, Kentucky.

Specifically, ERISA requires a plan’s fiduciary to “act with the care, prudence, skill and diligence that a prudent person acting in like capacity under similar circumstances would act”—also known as the “prudent person rule.”

As Kasten sees it, there are two major fiduciary responsibilities that the investment committee must fulfill. “First, they must have an undivided loyalty to the plan participants, and, second, they must operate at a prudent, expert standard of care.” Unified Trust highly recommends that at least one person on the investment committee receive fiduciary training from a company such as fi360. Resources for Retirement educates investment committees regularly; this has the added benefit of reducing the client firm’s fiduciary liability insurance premiums, Elco notes.

To offset their fiduciary responsibilities, many investment committees partner with or hire “discretionary fiduciaries,” or what ERISA terms “prudent experts.” These could include a registered investment adviser, investment manager, consultant or trustee responsible for managing continuous investment decisions.

Unified Trust breaks down investment committee members’ fiduciary responsibility into six key points: Know they are fiduciaries; know the responsibilities of each vendor or, as Kasten puts it, “where the bright lines are”; obtain indemnification insurance from the plan sponsor to indemnify them personally; ensure that the plan has fiduciary liability insurance to cover at least a percentage of assets in the plan; wherever possible, work with a discretionary trustee to off-load some of this; and document everything you do.

“The committee has to have a prudent process and document that process,” Kasten says. “If you do these things, you do not have to worry about ERISA litigation because you will then be bulletproof.”

4) Review investment selection criteria.  

The No. 1 topic at investment committees’ meetings is meticulous review of the investment options in the lineup. Advisers can provide invaluable insight and data—both quantitative and qualitative—for analysis of fund performance, consistency and style, which goes above and beyond reports from the plan administrator and investment managers, Elco says.

“Every quarter, the investment committee needs to go over regulatory updates, economic commentary and review, and investment reports and, in particular, take a hard look at those investments that are not performing according to the investment policy,” says Donald Stone, managing partner and CIO of Plan Sponsor Advisors of Chicago.

Quantitative criteria begins with determining the appropriate index and peer group for each investment option and ensuring that the fund is in the top quartile against that group and benchmark over the past three- and five-year periods. The fund should also be adhering to its stated investment style and charging reasonable expenses, when compared with its peers, he says.

Qualitative analysis starts with determining the stability of the financial institution and reviewing its people, philosophy and reputation. It can also include market commentary for each fund.

The adviser should also ensure that the investment committee asks whether each of its investment management partners has a culture of compliance. 

5) Address fees and other concerns.  

The ERISA 408(b)(2) requirement that plan recordkeepers disclose fees has put an additional burden on the investment committee, sources agree.

Investment committees need to pay careful attention to fixed-income, absolute-return, money-market and cash-equivalent offerings in their plans, in light of the ongoing market volatility and weak economy. The committees are also concerned about the decline in insurance wrapper providers for stable value funds, low yield on money market funds and the glide paths of target-date funds.

“There has been a movement to reduce the number of options, and we would expect that trend to continue, to where a plan may just have a set of target-date options and a set of four asset class options,” Brown says.

6) Identify successful outcomes.  

Increasingly, investment committees study participation, savings, investment, allocation, matching and risk tolerance data to determine what percentage of their workers are on the path to a successful retirement. Thus, outsourcing investment fund selection to a discretionary fiduciary frees defined contribution consultants such as Russell to guide a fund sponsor on bigger-picture decisions, Cohen says. “We want to focus our attention on how [sponsors] can help participants improve their chances of meeting their retirement income goals,” Cohen says. “While monitoring and evaluating funds is certainly very important, I try to help committees take a longer-term perspective on overall plan design and strategies to help participants save more, stay invested and have appropriate asset allocations.”

Some of the plan sponsors that Unified Trust advises have even begun to form retirement committees, which focus solely on the likelihood of their employees’ ability to retire successfully, Kasten says.

Finally, to retain a plan sponsor client, Trisha Brambley, president of Retirement Playbook Inc. of New Hope, Pennsylvania, reminds advisers about the importance of asking, on the spot, for feedback and ideas at the end of every investment committee meeting. This way, advisers can be sure they are meeting their clients’ specific goals and concerns, Brambley says.