Time for New Investing Rules

Many institutional investors are exploring new investment strategies.

A survey of more than 500 institutional investors from Natixis Global Asset Management’s (NGAM) Durable Portfolio Construction Center found most say that traditional investing principles have outlived their usefulness. Five years after the financial crisis upended markets, many institutional investors say the old rules of investing no longer apply in today’s markets.  

In the U.S., institutional investors (88%) feel strongly that traditional portfolio construction and diversification strategies are not ideal for most investors, and 60% of global institutions agree. Additionally, more than 70%, including a high concentration of sovereign wealth funds, say setting asset allocation and taking tactical advantage of market movements is difficult.  

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“The old road map no longer guides investors, and the new one is being drawn every day,” said John T. Hailer, chief executive officer of Natixis Global Asset Management in the Americas and Asia. “They need more tactical help with portfolio construction and asset allocation so they can build stronger, more durable portfolios that can better withstand the cycles.”

While 89% of institutional investors are confident in their ability to meet their own future obligations, that confidence does not extend to individuals saving for retirement. A large majority of institutions (81%) in the U.S. say the average citizen will not have enough assets in retirement, and seven in 10 (70%) globally say the same. Institutional Investors expressed greater concern in Latin America (88%) and the United Kingdom (84%).  

The widespread attraction to equities continues, with investors particularly drawn to global stocks. When asked to project which asset class will perform best this year, the top choice was global equities (27%), followed by domestic stocks (19%) and emerging market equities (15%). This optimism is reflected in most investors’ allocation plans for 2013, as 58% plan to increase their exposure to global stocks, 46% will add to their emerging market equity holdings and 42% will increase their weighting in domestic stocks.  

Lower yields have made the risk-reward tradeoff of bonds less appealing for many investors, as 43% say they plan to scale back on their domestic bond exposure in 2013 and 42% will reduce their global bond allocations. U.S. investors are slightly more optimistic within their own borders, with only 29% saying they will reduce their domestic bond allocations. Investors worldwide are bearish on gold and cash, as more than 80% anticipate lowering or maintaining their current allocations to each.

Most believe alternatives are essential to managing risk, and are adjusting their portfolios accordingly. Institutional investors have an above-average comfort level with alternative assets such as hedge funds, real estate, private equity and commodities. A large majority (85%) report that they own alternatives, and three in four say it is essential to invest in these strategies in order to diversify portfolio risk.  

Most (60%) plan to add to their alternative investments, or other assets that do not correlate with the broader market, in the next 12 months, with the most popular target areas being real estate (41%), private equity (36%) and infrastructure (30%).  

Most are also bullish on the near-term performance prospects for alternatives, with 71% predicting that the assets they own will perform better in 2013 than they did last year. Institutional investors in the U.S. are more cautious, with less than half (48%) projecting better year-over-year performance.  

NGAM’s 2013 institutional research study is based on field work conducted in 19 countries throughout the Americas, Europe, Asia and the Middle East. Telephone interviews were conducted in January and February with more than 500 senior decision makers from private pension plans (189), public pension plans (109), sovereign wealth funds (43), insurance companies (35), endowments/foundations (18), fund of fund companies (11) and asset consultants (97).

PSNC 2013: Duty Bound

A panel of attorneys at the PLANSPONSOR National Conference talked about 10 topics that should be on plan fiduciaries’ radars.

1.      Fiduciary Redefinition: When? Where? What? Why? The real impact on plan sponsors. 

David N. Levine, Principal, Groom Law Group Chartered said there is a 50% chance the Department of Labor’s (DOL’s) redefinition of fiduciaries will be issued by the end of the year. The big thing fiduciaries need to focus on is process, documenting those processes, and following plan documents. He said plan sponsors should document everything, keeping in mind that everything written can be used in court. Always use “may” in documentation never “shall,” Levine suggested. Plan sponsors don’t want to be locked into anything.

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James Fleckner, Partner, Goodwin Procter, added that the court views plan sponsors as fiduciaries who work in the best interests of the participants. Courts are very skeptical about fiduciaries that also have corporate responsibilities. It needs to be clear that fiduciaries are still looking toward the best interests of the participants.

When a fiduciary wears different hats, document the statements made in these different roles separately in communications, Levine said.

2. Target Date Fee Disclosure:  What does the DOL fact sheet really mean?  

Levine pointed out to attendees that the DOL fact sheet about target-date funds (TDFs) is not formal guidance. It is a document of best practices, but it may be used by the DOL for possible litigation, although to date no one has gotten hit with litigation on TDFs. The items in it are all about process. If you are using TDFs and/or propriety funds with your recordkeeper, document it. Use the sheet. Ask yourself why you are making these decisions, and document it.

Fleckner added that in the Tussey v. ABB, Inc. lawsuit, what moved the judge was the fact that the plan sponsor in the case did not compare other TDFs to the funds chosen.

 

 

3. The New Notice of Proposed Rulemaking About Lifetime Income Disclosures: So we have proposed rules, what does it mean?  

“The DOL got a little beat up about its fiduciary regulations so this is an advanced notice,” Levine said.  They want to see what a lifetime disclosure will look like. Many plan sponsors have already implemented these disclosures, working with their providers. This is a good time to speak with providers and understand the assumptions made in current disclosures, and perhaps implement this now. Eventually plan sponsors will be required to disclose this information to participants.

According toFleckner, documenting thoughts and assumptions are important. With this issue, the plaintiffs in any lawsuits will most likely be participants focusing on plans that are not being implemented properly. “Personally, I view these changes as positive. This is designed to force people to think about retirement readiness,” he said.

4. In-Plan Annuities: What are the rules and risks? 

Levine noted that the DOL issued safe harbor rules for picking an annuity provider in 2008. “They are all about process. Go through these and check the boxes,” he said, adding that this is a good way to document the selection of a provider.

In addition, in 2012, the IRS issued four pieces of guidance about lifetime income options. Two of them are defined contribution (DC)-plan related. One is about in-plan annuities and the question about whether you have to get spousal consent to take distribution.

 

 

5. Fee Disclosure: Is there still a risk for plan fiduciaries? Where is the DOL going from here?  

As fiduciaries, plan sponsors have to provide annual fee disclosures for participants, as well as quarterly disclosures. Levine noted that last year providers were time pressed, but this year they’ve had more time to work on disclosures. Fiduciaries should spend time looking at them again. Ask, for instance, does my summary plan description (SPD) match the disclosures?  Are there any inconsistencies? Does everything line up? Are our fees still good? This is part of the review process. Plan sponsors should benchmark fees periodically and make this part of their regular process.

6. Other DOL Enforcement: What is the DOL looking at? 

Other than fee disclosure, Fleckner said, it’s not clear who the DOL is looking at in its audits, whether it’s service providers or plan sponsors.  It is clear that the agency is focusing on enforcement.

According to Levine, the DOL is also looking at health and welfare plans, so plan sponsors should make sure they have processes in place and documented.

Levine warned that if two agents show up, plan sponsors should hire a lawyer.

But Fleckner said it depends on who the second person is. At times they just send an internal lawyer, but if a plan sponsor sees someone from the SEC or someone from the U.S. attorney’s office, they should hire an attorney.

 

 

7. IRS Enforcement: What fiduciaries should be watching for. 

According to Levine, the IRS tends to do performance soft touch audits, which are really compliance checks. Plan sponsors should use these to fix any mistakes. “If you don’t respond, you may be referred to the DOL and/or the Department of Justice,” he warned.

8. Investment Advice and Education: What are the risks for fiduciaries as they are trying to educate participants? 

Levinesaid fiduciaries should make sure provider contracts are clear about whether they are offering advice or education. Plan sponsors should also have fiduciary insurance.

The plan sponsor cannot rely on a consultant, according to the Tibble vs. Edison case, Fleckner said.  Plan sponsors are ultimately are responsible for the fiduciary responsibilities to the plan and participants.

9. Litigations Trends:  What should we watch for? 

There has been more litigation involving retirement plans than ever, Fleckner noted. Cases have concerned company stock as an investment option, fees, and conflicts of interest for fiduciaries. One other issue to be cautious about is doing due diligence to get the best provider for plans and participants.

“Where the next suit comes from exactly, I don’t know, but the kinds of things you can think about to protect yourselves, which we’ve been discussing for the last few days, is to be mindful of your role as a fiduciary so you can justify any disputes,” Fleckner said.

Levineadded that there has been a lot of activity in the 403(b) area about whether church plans or government plans really satisfies those definitions.

10. Tax Reform and System Redesign: How would proposed changes on tax treatment of contributions and capping balances impact the fiduciary? 

Levinepointed out that limiting deferrals that are tax-advantaged or capping participant contributions will be an administrative challenge for retirement plans. If the budget proposals are passed, Levine expects the industry will see more effort by small plans to offload their fiduciary liabilities and more discussion about multiple employer plans. Levine predicts the current proposals will not pass, and the government is more likely to change the compensation amount participants can defer from.

 


 

Judy Faust Hartnett 

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