Needing Flexibility
Whether it occurs in the form of a contractual obligation or as an added service—which an agent or representative may not be permitted to document—part of the normal service offering of retirement plan advisers includes monitoring the absolute and relative investment performance of the plan sponsor’s retirement plan investments, which may include investment managers, mutual funds, collective trusts, or other investments.
Most plan sponsors utilize a documented process-overlay, formally known as an investment policy statement (IPS), as a guide in defining acceptable investment performance and characteristics. In the IPS, the documented definition of acceptable investment performance versus unacceptable investment performance is described quantifiably. Some IPSs will augment the document with a sprinkling of qualitative leeway around performance or criteria-based issues that might be deemed abnormal. This leeway allows the fiduciaries to make “hold or replace” decisions on a specific fund on a case-by-case basis. In many instances, an ERISA-driven IPS also will include the logic of a decision tree, which outlines how a failing investment might be treated on a go-forward basis. (I admit there is not much “news” for the seasoned retirement plan adviser within this intro; however, I want to have everyone on the same page as we look at the present/future.)
How Does an IPS Address the Task of Reacting to “Failing” Investment Performance?
Although there also can be a variety of qualitative criteria identified within an IPS, this writing concentrates solely on failing investment performance. Within a single advisory firm, there is normally a thread of consistency as to “which” absolute and relative performance measurements are taken. Once an investment “fails” over a specific period, and the investment performance is logged as history, a retirement plan adviser (as well as each responsible plan trustee) is faced with the execution of a prudent course of action. Sometimes, the course of action is defined as a bright-line—where a specific occurrence calls for another specific action within the IPS (e.g., if the XYZ Fund fails to meet or exceed the appropriate benchmark over a three-year and a five-year period, whereby either the XYZ Fund must be replaced, or the course of action in addressing the failing XYZ Fund is left to the discretion of a fiduciary).
Industry professionals (advisers, attorneys, and fiduciaries) can make strong cases for either of the above actions when addressing the treatment of a failing investment.
What Happened?
The investment policy statement was dealt a curveball at year-end 2009.
When performing annual investment performance reviews, as of 12/31/09, advisers who employ S&P 500 Index-oriented investments were witness to a most interesting “fact-set.” Approximately $80 billion in S&P 500 Index-oriented funds (managed by three of what are considered to be some of the larger mutual fund firms) failed to meet or exceed the S&P 500 Index for the three-year and five-year performance periods. (I do not recall such consistency of failing-performance—where three of the larger firms failed to meet both the three-year and the five-year benchmark performance—since indexing first came in vogue in the 1980s). To add to the consternation, only one of those funds met the 50th percentile of the peer group for the same three-year and five-year periods. All other peer-group measures (on the three-year and five-year) were below the 50th percentile.
This is not an indictment of the passive strategy or the managers of those funds, as all investment managers were party to unprecedented volatility and cash-flow strain over the previous five-year period.
What (If Anything) Needs To Occur in Our IPS?
Is this type of performance an aberration or a harbinger?
Once the carnage and corresponding recovery occurred, many advisers employing a bright-line performance measure (forcing them into action) were left asking, “Does the retirement committee really need to seek a replacement of the XYZ S&P 500 Index-oriented fund; or does the IPS need an update that provides more flexibility around the concept of ‘overriding’ the bright-line, inflexible, and unambiguous test?”
Now may be a perfect time for advisers to review a plan sponsor’s IPS for such a scenario.
Steff C. Chalk is CEO of the Fiduciary Consulting Group, a fee-only fiduciary consulting practice serving corporations and nonprofits. A judge for the PLANSPONSOR Retirement Plan Adviser of the Year award, and a faculty member of the PLANSPONSOR Institute, he is also the co-author of How to Build a Successful 401(k) and Retirement Plan Advisory Business.