The Game-Changers
Five years ago, CAPTRUST Financial Advisors often did not even see a formal RFP process while competing for new mid-size plan clients. “Now, you can hardly get a client without one,” says Fielding Miller, its Co-Founder and CEO. “It started upmarket, and it is moving its way down.”
That means advisers now have to spell out their fees and what they provide for them, and Miller likes that. “It flushes out the pretenders,” he says. “It used to be that an adviser could sell to a retirement plan based on the adviser’s relationship with the CFO—maybe he was his golfing buddy, or brother-in-law—but now they have to compete on merit.”
Much can change in a short time in the retirement plan world. Some of the industry’s leading thinkers talked recently in interviews about a handful of developments that have most affected retirement plan advisers in the past five years.
1. The PPA: Plan Design Comes to the Forefront. The passage of the Pension Protection Act (PPA) and its automatic-enrollment safe harbor took a big step toward getting more employees to start putting aside money for retirement. “For the first time, they [sponsors] have a government-sanctioned, much less risky way to help people save,” says Bradford Campbell, a Washington-based attorney who is of counsel at Schiff Hardin LLP. “You had employers on the leading edge doing automatic enrollment before PPA, but they were taking some legal risk. Now, they have a path, a relatively low-risk way from a legal perspective, to help solve those problems. Ultimately, we will see billions of dollars of employee savings as a result.”
A lot of advisers who work with smaller plans have, for years, put a big premium on one-on-one meetings with participants, says Donald Stone, President and Co-Founder of Chicago-based Plan Sponsor Advisors. “That moves the meter so little. We have been saying it for years: If you want to make a difference in plan participants’ lives, work on plan design,” he says. “Work with the plan committee at the fiduciary level, as opposed to getting out there to do a lot of participant meetings.” Most participants do not want to learn about investing and just want direction on what to do, he says. “The average participant spends less time preparing for retirement than they do preparing for their next vacation,” he adds.
PPA has changed how sponsors and advisers approach plan design, says Vince Giovinazzo, CEO of Aliso Viejo, California-based 401(k) Advisors, Inc. “It opened the door for sponsors and advisers to pursue the behavioral-finance aspects,” he says. “The last 25-plus years that I have been in this business, it has been about consumerism: more choice, more flexibility, more technology. However, by and large, many of the decisions that participants made have not produced the desired outcome.” PPA allows for a plan design that will lead to successful results for participants, he says. “It is probably about fewer participant choices, not more,” he adds.
However, although the passage of PPA made usage of automatic plan features more common, there is still work to be done. Advisers need to work with sponsors to use automatic enrollment aggressively enough to get the right results, Stone says. “We ought to be ‘re-enrolling’ people who were never in the plan, and have been at the company for 20 years. The reality is that there is no pushback when we do that,” he says, “and the default [deferral rate] ought to be done at a higher level, and we should increase it more aggressively.”
Plan design needs streamlining beyond automatic enrollment, Giovinazzo says. A lot of evidence indicates that the participants who take loans are those least able to afford it, he says, so he predicts the industry likely will see plans adopting more-stringent loan provisions, or no loan provision. Likewise, he says, many investment menus need fewer choices, to avoid participant confusion. “It is important to have the courage to discuss behavioral finance and human behavior with sponsors,” he says, “because it may mean the difference in the adviser continuing to deliver value.”
2. Target-Date Funds: Bringing Institutional Discipline to DC Investments. Most sponsors have chosen target-date funds as the QDIA (qualified default investment alternative) used in automatic enrollment. Their appeal also plays into behavioral finance. “The vast majority of people—the delegators—need a put-together kind of allocation,” Stone says, “as opposed to, ‘Here are all the puzzle pieces, now put the pieces together.’” Target-date funds offer an opportunity “for individuals who are not astute at investing to create diverse portfolios that are better and more in line with their long-term needs,” says Jamie Cahn, Managing Director at M&I Institutional Trust Services. Participants hold more non-U.S. equity, fixed income, and alternative investments as a result, he says.
Target-date funds help bring institutional investment-management discipline to DC plans, says Ed O’Connor, Managing Director at Morgan Stanley Smith Barney. The old days of employers picking a bunch of brand-name retail mutual funds do not cut it anymore, he says. As sponsors get more knowledgeable, he predicts a move toward multimanager target-date solutions. “It is about choice. The first generation was one fund company’s target-date funds,” he says. “Now, sponsors are asking, ‘Do we think that one fund company will always be the right solution in every asset class?’”
These days, employers ask more questions about target-date funds. “I do not think we see a lot of plan sponsors changing that option yet, but we do see a lot of plan sponsors questioning if they made the right choice,” Stone says. “They are saying, ‘Maybe I should not just take what my vendor has to offer.’”
Some question whether their participants need less-generic solutions. “Target-date funds will continue to have a leadership position, but they are being threatened by more-customized approaches,” says Charlie Nelson, President of Great-West Retirement Services. “The challenge with target-date funds is that oftentimes they are done for the average participant. We are starting to hear more discussion of taking it down to the individual level.”
Target-date funds will not maintain the hold they have on the marketplace today, believes Lou Harvey, President and CEO of DALBAR, Inc. “It may be sustainable for young, new investors,” he says, “but, as soon as they reach 40, people have some assets and some complexity in their lives—they are married, they have kids—and there are lots of complexities that are not included in target-date fund design.”
Customizing investment strategies, such as with managed accounts, requires getting some information from participants, which they often have been reluctant to give. Communicating regularly with participants about the expected retirement-income level for their current savings rate helps motivate them, Nelson says. “Most people are not happy with the level of income that their current account would generate, so it creates a dialogue to get that information,” he adds. Giving people the ability to provide information over their working lives also makes a difference, Harvey says. “They will add data when their life events happen,” he says, “and, over time, as the wealth in their account increases, people are more and more willing to provide the information.”
3. The 2008 Crash: Spotlighting Retirement Readiness. The fall 2008 stock market crash led to the increased questions about target-date funds, and other questions about 401(k) plans’ effectiveness. What happened in 2008 has been called a once-a-century event, Giovinazzo says, but history tends to repeat itself, and sponsors and participants often have relatively short memories. “If you go back to the first big crash in the 401(k) marketplace, in 1987, we had the same time of dialogue,” he says. “The market reversed, and the conversation went away.” A big downturn will happen again, he says, making it more critical that sponsors and advisers have helped position participants to get better outcomes from their retirement plans.
The market downturn has had a lasting impact on Baby Boomers, O’Connor thinks. “Baby Boomers, when they had a market correction in earlier years, were 20 years from retirement. Now, most Baby Boomers are in retirement, or see retirement on the horizon,” he says, “and most people have not thought through what to do. Income guarantees eventually will become a bigger part of this, but I am not sure in what shape or form.”
The market crash brought attention to participants’ retirement readiness—of lack thereof—as lots of people with plans to retire saw their account balances decline. That has led to more talk about retirement-income products, and the industry now has designed products with a base guarantee that helps participants avoid worrying about a market crash six months before they want to retire.
Yet, not many plans or participants have utilized these products. “Progress comes sometimes in slow steps,” Nelson says. He points to the Obama administration’s support of these products’ use in DC plans, recent U.S. Department of Labor (DoL) and U.S. Department of the Treasury hearings about retirement-income products, and The SPARK Institute, Inc.’s efforts to increase portability as positive signs. “Maybe plan sponsors’ adoption has not been the tidal wave that some expected,” he says. “It may seem as if we have not moved the dial completely yet, but we are laying the foundation for future growth.”
The DoL appears likely to issue regulations this year that include a methodology for expressing a participant’s current account balance as a future income stream, Campbell says. “That does not sound earth-shaking, but it has the potential to change behavior,” he says. “It could be more significant than it seems.”
4. Fee Disclosure: Fees, Value, and Positioning. Revenue-sharing lawsuits brought plan fees into the limelight, form 5500’s Schedule C requires disclosing direct and indirect fees paid to service providers, and the new 408(b)(2) regulations will compel providers to reveal details about their fees. The big question: Will that cause a sponsor rush to the cheapest options?
“Anytime you look at a menu of choices, that is naturally what people do,” Nelson says. “There may be some of that.” However, employers should remember that the fiduciary guideline does not mandate it. “Fiduciary responsibility does not require you to get the lowest price: It requires that you get the best overall value,” he says. “It is about getting the best value for the services that best meet the needs of your participants.”
O’Connor compares the situation to when auto sellers had to start posting detailed pricing stickers on car windows years ago. “Is everybody buying the cheapest car in town? No,” he says. “The reflex initially will be very much a quantitative analysis, and to move to cheaper options, but I think that, quickly, that will turn to a focus on value: ‘What are we paying, and what do we get for it?’”
Still, the new era of fee disclosure already has required industry players to think about their positioning. “We recognize that we are going to be a boutique, high-touch organization, as opposed to a plan-in-a-box with a lower fee,” Cahn says. Its strategy differs from commoditized recordkeeping shops in that it offers services like customized plan design and handholding of participants entering the distribution process, he says.
Advisers have to consider their positioning, too. “There is nothing wrong with high fees, as long as you have high value,” Miller says, “but there are plans where the plan sponsor is paying a lot and may not know it. The irrational fees will go away.”
Retirement Benefits Group has been doing fee disclosure for about 10 years, says Larry Deatherage, a San Diego-based Principal and Founder of the LPL Financial affiliate. So, mandated disclosure does not affect his practice directly, but he does worry about a sponsor tendency to focus on advisory fees and not the services provided. “We have to compete with these guys rolling in as low-cost providers, whether they provide the same services or not,” he says. “Many times in the RFP process, the higher-bid proposals get thrown out first.”
Lockton Companies, LLC, already benchmarks its own advisory fees for clients as part of its fiduciary work, says David Altimont, a Dallas-based Senior Vice President. “Part of our business model is to make sure that our clients have full transparency,” he says. “We are going to continue to see a lot more attention paid to fees as a result of 408(b)(2). That will be very positive for some advisers, and not so much for others.”
5. The Rise of Specialist Advisers: Sharing the Fiduciary Burden. Fee-disclosure increases come at the same time as employers’ concerns about their fiduciary liability grow—intensifying their interest in working with an adviser willing to serve as a named fiduciary. That has been a big boost to some forward-looking advisers. Altimont started at Lockton about seven years ago. “The business was clearly shifting over to the RIA, fee-based model,” he says. “We saw this coming six, seven years ago, and we built our practice for this day. The market kind of came to us, rather than us adjusting for it.”
Mid-size firms allowing fiduciary advisers have been a magnet the past few years. CAPTRUST has increased its advisers by 50% to 75% just since the 2008 market crash, Miller says. Large plans have wanted fiduciary advisers for years but, in the mid-market of plans that have assets of at least $10 million but less than $1 billion, being a named fiduciary essentially has become mandatory for advisers, he says. “From the middle market up, it is a deal-breaker if you will not be a fiduciary.”
Some wirehouses have put together teams of specialist retirement plan advisers in response to sponsors’ increasing expectations. “The bar has been raised, and it will continue to be raised some more for awhile,” says Morgan Stanley Smith Barney’s O’Connor. “We are encouraging more of our business to be done with our specialists. When you look at the resources we employ here, we put an inordinate share of our resources toward the specialists, and we encourage other financial advisers to partner with the specialists.”
The generalist adviser serving retirement plans has become rarer in the past five years. Even for mid-size independent advisories, it will get tougher and tougher to win new plan business, Deatherage predicts. “It seems as if there are more DC lawsuits than ever, so clients are looking for a big, strong backer,” he says. “Employers are attracted to larger groups now. Even if you have 20 or 30 plans, it is going to be tough to compete.”
The “onesies” or “twosies” advisers who work with a plan or two now do not stand much chance of competing, Altimont says. “We will see in the next three to five years much more concentration in the industry,” he says. “The standard is going to increase as we move forward, and advisers are going to be held more accountable. From our perspective, that is a positive.”
The “accidental plan adviser” who gets a 401(k) plan or two through working with wealth-management clients is getting squeezed out of the market, Harvey thinks. “There is nobody I know who would suggest that ERISA will get simpler as we go forward. There will be more enforcement of more-complex rules,” he says. “Almost by definition, it will be a specialist market.”
Some see it shaking out a little differently. Mid-size, large, and jumbo plans almost exclusively work with specialists at this point, Stone says. “However, the reality is that, in the small-plan space, anything less than $10 million, true specialists are few and far between,” he says. “It becomes pretty marginal business for a lot of folks. In an ideal world, there would only be specialists, but it is hard to get the economics to work.” Says Nelson, “The generalist adviser will not go away. There are just not enough specialists in the business to provide that service to the nearly half-million 401(k) plans.” —Judy Ward