Questioning Accepted Theories

A look at 2011 and a distant glance beyond. 
Reported by

Every retirement plan adviser possesses a level of industry experience. One of the benefits of having longevity in any industry is that it serves as the basis for perspective.

This year, 2011, plan advisers are facing three changes that will have a major impact on business and the clients each adviser serves. Full fee disclosure, regulated in the form of the Department of Labor’s 408(b)(2), is certain to make it simpler for plan sponsors to identify the fees they pay. The oversight of investment advisers vis-à-vis registered representatives and the corresponding standard of care delivered by each registered representative are still pending. These pending issues­ bounce between FINRA and the Securities and Exchange Commission (SEC) with the predictability of a political football hitting the turf. Registered representatives are positioning at the ready for whatever fiduciary residue emanates from Washington, D.C.

What Lurks on the Horizon?

What might be the next area that may alter the way every­ retirement plan adviser conducts their business?

A foundation of our industry is increasingly the object of question and criticism. At the risk of preaching heresy, Modern Portfolio Theory (MPT) is “on the hot seat” as the exclusive due-diligence support system for every decision to buy, hold, or sell a security. There have been a handful­ of industry mavens willing to go public with strong arguments against the use of MPT. Looking objectively, it is difficult to fathom that there has not been a “better way” to identify, take action, and measure results than a theory conceived in the 1950s.   

There is no need, yet, to include MPT among the antiquities of our industry—such as the ticker-tape machine—but, with more frequency than ever before, the investment community is openly questioning: Is MPT still the one-size-fits-all tool it was once perceived to be? or Does MPT even work at all?  For the benefit of clients, plan advisers should periodically give consideration to alternative investment theories. Doing so will either strengthen any decision to accept MPT for another period of time, or enlighten an adviser to the fact that there may be a better theory.

Your Behavior Makes a Difference

Our industry has become infatuated with the term “behavioral­ finance” and most everything that it delivers.  Since jam is sold “this way,” your 401(k) plans need to be designed­ “in a very similar way.” Perhaps.

Behavioral finance is taking the lead in a substantial number of 401(k) plans—because why?  Is behavioral finance alone truly an acceptable alternative for a plan sponsor using a fantastic retirement plan adviser?  (I would argue, no.) There is a perverse complexity associated with making future decisions based upon the historical actions of emotional individuals. But, for the benefit of the plan participants, there must be a sanity check. Have we, as an industry, been led down a path that plan advisers are far too willing to accept? A path where we may not be able to recognize the flaws in our own logic?

Behavioral finance is a rare blend of art and science. The science is the measurable and repeatable component. But the results are a combination of people’s actions—based upon their ever-morphing emotions—mixed with what we believe to be orderly markets.

Plan advisers, with the tutelage and oversight of compliance departments across the country, are forever informing the masses, “Past performance is not indicative of future results/returns!” Are today’s retirement plan advisers setting themselves up to be very wrong by accepting the results and science portion of behavioral finance as “being indicative of future results”? Perhaps.

The point is not to dispose of MPT or behavioral finance. The question becomes, How do you know that your clients are receiving the best; and what are you willing to accept? In the long run, by such questioning, MPT and behavioral finance become more refined. They become better tools than they were yesterday, and can ultimately deliver better results to clients. That is, unless there is something better out there.

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.