Articles | November 17, 2023
What are the three most important things a DC plan sponsor should be laser-focused on? Process, process, process.
We dig into the latest investment consulting trends and best practices for putting together a retirement portfolio that’s user-friendly and cost-effective for participants — and the structures you need to have in place with your plan. This includes putting in writing what you did, why you did it, and what you’re doing going forward.
Join Rick Reed and Jarred Wilson as they talk to Segal Marco Advisors’ John Hume about how to maximize retirement benefits for your workforce. Listen now.
Narrator: Governance, operations, investments, compliance. These are the four pillars of risk that defined contribution plan sponsors need to stay up on. Every quarter, we're going to be giving you the scoop, the skinny, the lowdown on all the latest developments in the field, everything you need to know to stay current and informed. We're going to be talking regulatory issues, best practices, investment strategies, all of it, about what it all means and more important, what it means to you. So put on your swimsuit. We're going to be doing some deep dives. Welcome to the Retirement Plans Insider from Segal.
John Hume: I always say to my clients, what's the most important thing in real estate?
Jarred Wilson: Location, location, location.
John Hume: Those are the three most important things. What's the three most important things in being a trustee on any plan? Process, process, process. So, you have to have a process in place that gives you buy, hold, or sell decisions on the investment front through an investment policy statement, right? You have to work with a record keeper that has a platform that enables you to put these funds on your plan.
And when you put the funds on the plan, you need to make sure the appropriate share classes are also available, so that most funds are now looking at revenue sharing, because that's part of most lawsuits, having revenue sharing in your plan. And it's also being questioned on fiduciary liability insurance questionnaires. So your trustees are now being asked, do you use active and passive strategies? If you don't use passive strategies, why not? They literally ask that on the fiduciary questionnaires. Do you have revenue sharing in your plan? If so, is it used to pay for plan costs or is it returned back to participants? What else do they ask? Have you reviewed your record keeping fees and are they reasonable relative to other providers? That's a question on fiduciary liability now. When is the last time you took your record keeper out to bid? When is the last time you took your investment consultant out to bid? Those are questions being asked.
Rick Reed: I've seen those. Yep.
John Hume: Yep. So that's what trustees are concerned about in terms of the lineup, right? We've talked about sort of the tier structure that we think about. So, obviously, now that we've been provided relief, relief in the form of having a qualified default investment alternative that enables the trustees to pick an appropriate qualified default investment alternative as their default investment option for the plan. So that's the first step in deciding in building a fund lineup for a plan, because that's your default fund and where most of the assets typically go to, and so it typically has taken the form of a target date fund. So those are the funds where you start with a high equity position and over time it automatically lowers the equity position and increases the bond position to lower the overall risk of the portfolio for your entire career. And you don't have to do anything.
It's sort of a one stop shop. From there, then, after you figure out what your QDIA will be, you would move on to individual investment options for members who want to create their own diversified portfolio beyond the target date funds. And those would be the common asset classes that you would think of. And they would also utilize both active and passive management strategies. So you would look at large cap US equities, mid-cap US equities, small cap US equities, international equities.
And then on the fixed income side, you typically have a core or core-plus bond portfolio. So that's US fixed income, and you typically have a stable value portfolio. So all in, you're looking at anywhere from 10 to 15 individual options typically, or eight to 10 individual options. And then you have your suite of target date funds, and those usually comprise about 10 other funds, but those are meant as sort of standalone one and done type of investments. So you've created a portfolio where participants can build their own target date fund, if you will, of their own investment strategy or go into the default option that has an investment strategy embedded in it.
And then for people who want even more options, we have seen some people starting to add self-directed, directed brokerage options, which are a whole different animal where you need to analyze the provider of the brokerage platform, and you have to be pretty astute at trying to manage what investment options you are going to allow within the self-directed brokerage window. In other words, what we see is, some clients will do, a percentage of assets can go into the self-directed brokerage window, and those assets can only buy mutual funds, or it can only buy mutual funds and maybe covered calls, or, they typically don't allow for master limited partnerships, which could hurt the... What do you call it, eligibility for the plan. Is that right? Plan eligibility?
Rick Reed: Yeah, plan eligibility.
John Hume: So it would impact plan eligibility. So that's sort of the structure within which we have these building blocks of putting a portfolio together for the participants to choose from. A natural progression within this is, you have to be very cognizant of the fees you're paying for the underlying investment options. And so, looking at, and in our meetings, on a quarterly basis, we look at the current expense ratios of the funds that you have in your lineup relative to the median of funds in that asset class. So you can see and monitor, you're required to monitor as a fiduciary, monitor those fees relative to the averages, and you should be at or below average within every asset class, given that you have, whatever size of your fund is, that's your buying power. And so your buying power is higher than the individual, and that's the argument for not having any other share classes in funds other than institutional share classes, with the least cost and no revenue sharing involved.
That's been the general trend. CITs aren't always better than mutual funds, I'm finding. From an administrative perspective, people knowing what the hell the fund is perspective, they can't see it in a newspaper. It's less user-friendly for the underlying end user, which is the participant. But there's a mandate there where trustees are tasked with, or boards are tasked with finding the least cost shares. So that a lot of times can take the form of a CIT. A lot of money management firms are coming down in their fees. We've seen a general trend of fees coming down in these plans over time as more and more transparency around the fees has come into fruition. And now, as a result of that too, we're taking the next step in, so that boards can look at all the costs associated with the plan because we know it's not just investments and it's not just the cost of your consultant.
There are many other professionals involved, including a record keeper that we need to monitor and make sure the fees being paid are reasonable. There's an auditor that you need to look at, and there's other costs associated with the plan, not just investments in our services.
You can still have revenue sharing in a plan, and you can still use that revenue sharing to offset costs. There's nothing illegal about doing that. It's just the transparency to the participants isn't as strong as when you don't have revenue sharing. And the end game for the DOL, is to have transparency about everything around these plans, because most people, this is their primary retirement fund. And so, the government is, and always will be heavily involved in this. It's trillions of dollars in assets that people are trying to retire with. And so they're trying to make it as user-friendly and as cost-effective possible. And that's what our goal is when we consult to funds that we work with.
Rick Reed: So John, would you, going back to what you said earlier, while that while revenue sharing is still a best practice, it matters-
John Hume: Not having revenue sharing.
Rick Reed: Well, but if you do have revenue sharing, it's still an acceptable method-
John Hume: It's an accepted…
Rick Reed: As long as you have a process around it.
John Hume: Exactly right. It goes back to the three most important things, process, process, process. So as long as you, whatever structures you have in place with your retirement plan, you need, written down, what you did, why you did it, and what you're doing going forward as a result of it for monitoring purposes.
Rick Reed: So another example would be you can have an ERISA account, where some of this revenue sharing is flowing into to offset potential plan expenses, but there are some rules around that that says you really need to use it by the end of that plan year, that it has to be used for certain plan related expenses, like communications or something. And as long as they're doing that, that's part of the process.
John Hume: Exactly right. Yep. Now, most people are starting to opt for having flat dollar costs across the board for all providers except for the investment management industry, which will always be on a basis point program, I believe. So definitely the trend is away from revenue sharing, towards no revenue sharing funds, having flat dollar record keeping costs and flat dollar costs associated with the plan, and monitoring all those costs on at least an annualized basis.
Rick Reed: I ran into a very interesting scenario for a corporate client where ERISA council is very adamant about... We were doing a record keeper search, and when looking at all the pricing from the finalists and the respondents, fiduciary counsel was very adamant about, we want basis points, not a fixed dollar amount per participant. And when we went back to look at the various quotes, if you looked at the number of participants and multiplied by the fixed amount, it actually was cheaper than the same proposal of basis points on the assets. So it's just another way. The assumption is basis points is always going to be higher. Well, I don't know if I'll say that. It was just a very interesting scenario where, $50 per participant fixed fee was better than the 11 and a half basis points that they were looking to get as their proposal. Because the 11 and half basis points …
John Hume: That's the thing, one that's, so what most boards are doing now is looking at how the fees are being paid, right? And so a lot of clients have either a combined thing where they have some revenue sharing and some hard dollars coming out to pay for the costs. And what we're starting to see is, before what everything happened was, you would use revenue sharing to offset the total cost of the plan, and now we're moving towards just having flat dollar fees cover the plan. But there's different ways of getting to the same result, and that is, we have some clients that will do, they'll have an investment lineup and then charge a basis point fee for everyone that has a balance in the fund. Now, that's fine. So you can basically say everyone's going to get charged 10 basis points, so point 10 of 100.
And so, the way to think about that though is the higher balance participants are going to pay a higher record keeping fee than the lower balance participants, because it's based on the assets in your account. That's how you get charged. So it's a less fair way than doing a hard dollar fee of $200 per person per year, $50 a quarter. But the counter to that is you also have members, especially in the Taft-Hartley space, I don't know, is this going to be Taft-Hartley specific?
Rick Reed: It's mostly defined contribution. I mean, it's mostly-
John Hume: So I'm not going to make this that point then with the Taft-Hartley stuff.
Rick Reed: But just to carry on, what you were saying is, wait, I lost my train of thought, but which is why the fixed dollar amount is more transparent. Because I've had discussions with various legal counsel where they say, where the view is when it comes to record keeping services. Why should somebody be paying more for a distribution to be processed than somebody else, when in reality that distribution costs the same amount, whether you're doing it for somebody with a million dollar balance or a thousand dollars balance.
Jarred Wilson: The participants understand as well.
John Hume: I think it's easier to understand $50 coming out of your account every quarter, than 10 basis points coming out of your account every quarter, especially if you have $200,000 and someone else has $2,000. It's a very big difference in dollar terms of what people are paying for the exact same service. Fees are part of the assessment when you're looking at an investment option for a DC plan and not the entire assessment, you have to look at the returns, and we always show returns net-of-fees so that you're comparing apples to apples.
So all things being equal in terms of return, the risk the portfolio makes, the people in the process are in place that the investment manager, all things being equal, you have faith that both managers can run the funds, run the assets pretty well, either one. I mean, it comes down to the fee at the end of that. So to your point, right, there's higher costing ones and lower costing ones, all things being equal, I would go with the lower costing one. If the higher costing one has better performance and has done better over time, that's a perfectly legitimate reason to pick that fund over the other one.
Rick Reed: Well, isn't it fair to say that also in that discussion is while you're looking at risk and you're looking at performance, we also look at, or it's common to also look at the management team and how secure they are, how long they've been there. If there's been change that could change your expectation of what future performance could be. Because if you're relying on past performance, you may not have the same people making those same decisions, or you may have a different investment philosophy with the new people. So there's a lot of different criteria.
John Hume: The four Ps: people, performance, philosophy, and price.
Rick Reed: We want to thank John for spending time with us today to discuss investment consulting best practices. We truly appreciate John's insights and expertise, and we thank you all for listening to us on today's podcast, and hopefully you learned a thing or two about investments and 401k and other retirement plans. Here at Segal, we will continue to be your trusted resource for any and all questions related to maximizing retirement benefits for your workforce. Thank you for joining, and have a great day.
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