The Float

Target-Date Report from the Senate Special Committee on Aging

Back on Tuesday we mentioned that Herb Kohl's Senate Special Committee on Aging would hold a hearing on target-date funds, with special emphasis on their role in retirement plans. And hold that hearing they did.

The testimony the committee heard was all well and good, but the substantive issues are best captured in this staff report, revealingly subtitled "Lack of Clarity Among Structures and Fees Raises Concerns." If you're into this sort of thing, we recommend that you take a look.  The good stuff starts on page 8.

The Target-Date Debate...

...heads to Capitol Hill tomorrow, as the Senate Special Committee on Aging holds hearings on conflicts-of-interest in target-date vehicles. Here's a four-minute preview of some of the issues from CNBC, featuring Interlake's friend and colleague Mike Alfred of BrightScope:

In addition, Senator Herb Kohl of (the great state of) Wisconsin has just released a Government Accountability Office study of auto-enrollment in 401(k) plans. Here's GAO's overview:

Automatic enrollment appears to significantly increase participation in 401(k) plans according to existing studies, but may not be suitable for all plan sponsors. Some studies found that participation rates can reach as high as 95 percent under automatic enrollment. Available data indicate that the percentage of plans with automatic enrollment policies increased from about 1 percent in 2004 to more than 16 percent in 2009, with higher rates of adoption among larger plan sponsors. In most cases, these plans automatically enroll only new employees, rather than all employees. We also found that automatic enrollment may not be suitable for all plan sponsors, such as those with a high-turnover workforce. Further, some data show that while automatic escalation policies--which automatically increase saving rates over time--are increasingly common, they lag behind adoption of automatic enrollment. In combination with low initial contribution rates, this could depress savings for some workers. Also, the emergence of target-date funds--funds that allocate investments among various asset classes and shift to lower-risk investments as a "target" retirement date approaches--as the typical default investment raises questions in light of the substantial losses such funds experienced in the past year.

More on Time's Recent 401(k) Takedown

Yesterday we offered a few thoughts on Stephen Gandel's furious assault on defined-contribution retirement plans. Today we'll pick up where we left off...

Gandel's core argument is that workers would be better off in traditional defined-benefit pensions than in defined-contribution plans.* In the abstract, we can't argue with that, assuming all such pensions were (and were to remain) fiscally sound. But we know that many, in the private and public sectors alike, aren't fiscally sound. So it strikes us as a little too simple to hold up traditional pensions as the rock-solid, safe-and-sound alternative to the 401(k). That doesn't diminish the problems in the 401(k) world. Not at all. But it does complicate the question of alternatives a little.

Gandel notes the virtue of portability, a clear advantage of DC over DB. (Alas, the accompanying quality of "raidability," the opportunity to pillage one's retirement account during one's working years, has impaired many participants' balances in a big way.) In an economy where people change jobs and careers more frequently than ever, portability will be an indispensable part of any retirement plan regime policymakers might come up with.

Gandel returns repeatedly to the perils of retiring in a down market. "If you retired last year," he writes, "you're toast." Um...no. Not necessarily.

As we've noted in the space time and again, the "retirement moment" isn't the true finish line; instead, it's one's life expectancy. Now, it's absolutely true that taking initial withdrawals from a depressed portfolio does real damage to that's portfolio's likelihood of surviving as long as its owner. But again, the solution for those at or nearing retirement is absolutely obvious and utterly simple: Hold a few years' living expenses in safe, liquid positions. Doing so eliminates the need to tap (or, worse yet, fully annuitize) a beaten-down portfolio of securities.

If an investor (in a 401(k) plan or not) experiences a substantial decline in portfolio value at the retirement moment, he or she shouldn't annuitize that portfolio, and should minimize (or, better yet, fully avoid) tapping any holdings whose prices have fallen precipitously.

The system has the technology to facilitate this approach, one that mitigates (but doesn't eliminate) the single biggest disadvantage of DC plans relative to their DB counterparts: the concentration of longevity and investment risks at the individual level.

Gandel finishes his piece with a discussion of "retirement insurance" proposals. Though we're pretty darn skeptical about a lot of products that mix investments and insurance, we're not remotely "anti-insurance." If our systems of social insurance are inadequate or unreliable, we'll have to supplement them with private/individualized resources.** Getting those systems right is one of the most important problems  policy makers, plan sponsors, service providers, and individual participants will tackle as our population ages.

We aren't thrilled by the status quo in the 401(k) marketplace, but we don't think the system is beyond repair. Indeed, recent legislative and regulatory changes have helped, and more such improvements are on the way. Unless and until the system is overhauled in some fundamental way, the moral and practical imperative is to make defined-contribution plans work as well as they can.

~~~~~~~~~~~~~~~~

* "Some said they were happy with their 401(k)," Gandel writes. "But all the people who shared their financials with us would have been better off in a pension." 

** Our view is that they're more inadequate than unreliable. We think Social Security will be around when today's young workers retire, but it'll never be enough, and can't be enough.

Source

Stephen Gandel, "Why It's Time to Retire the 401(k)," Time, October 9^th, 2009

Time Takes a Mighty Swipe at the 401(k)

In a recent issue of Time, Stephen Gandel puts the defined-contribution retirement plan on trial...and convicts it of some pretty serious offenses. Check out Gandel's opening salvo: 

[T]he 401(k) was never meant to replace the employer-guaranteed pension fund, supplemented by Social Security, as the cornerstone of our nation's retirement system. But propelled by a combination of companies looking to cut costs and consumers who wanted control of their retirement destiny, that's exactly what happened.

The ugly truth, though, is that the 401(k) is a lousy idea, a financial flop, a rotten repository for our retirement reserves.

Gandel guides readers through a familiar set of concerns: inadequate savings during participants' working years, ineffective management of individual accounts, and the risk of severe market downturns coinciding with retirement.

We think Gandel is a little too dismissive of the benefits of saving more during one's working years, and it's plenty clear to us--from our own experience and systemic data--that many participants don't manage their accounts prudently or effectively.* It's important for sponsors and fiduciary service providers to implement rules and processes that make these problems less likely and less consequential.

But what about the risk of retiring in the middle of an ugly market? This is indeed a big problem, but we don't think it's quite as insurmountable as Gandel suggests. Here's the core of his argument (emphasis added in bold):

In what must seem like a cruel joke to many, the accounts proved the most dangerous for those closest to retirement. During the market downturn, the 401(k)s of 55-to-65-year-olds lost a quarter more than those of their 35-to-45-year-old colleagues. That's because in your early years, your 401(k)'s growth is driven mostly by contributions. You control your own destiny. But the longer you hold a 401(k), the more market-exposed it becomes. It's a twist that breaks the most basic rule of financial planning.

By definition, Gandel's point about contributions playing a larger role in smaller accounts is exactly right. But there's absolutely nothing about the 401(k) system that requires larger accounts (or accounts of any size held by older participants) to be "more market-exposed." As we see it, there's a very simple solution for (rationally) risk-averse participants for whom volatility in their accumulated assets dwarf the impact of their ongoing contributions: Reduce the risk (i.e., expected volatility) of their accumulated assets while directing their contributions into asset mixes with higher expected long-term returns. 

Such a strategy would impose a capital preservation strategy on a participant's accumulated capital while taking full advantage of dollar-cost-averaging with his or her ongoing contributions.

Practical concerns? Any halfway-decent recordkeeping system should make this type of strategy very simple to implement. We can even envision a world in which a plan's automatic provisions "make inertia work for employees, not against them," as Gandel writes, by defaulting participants into this kind of approach.

We'll offer a few more thoughts on this important story tomorrow.

~~~~~~~~~~~~~~~~

* The leading causes of poor account management are (1) risk-taking that's wildly off the mark (which is to say, much too much in some cases and much too little in others) and (2) performance-chasing behavior, piling into what's (temporarily) hot and bailing out of what's (temporarily) not.

Source

Stephen Gandel, "Why It's Time to Retire the 401(k)," Time, October 9^th, 2009

Boise Fiduciary Symposium

Two weeks ago, I was participating in the first morning session of the Boise Fiduciary Symposium, a two-day event sponsored and organized by Matthew D. Hutcheson LLC, with Matt himself as the master of ceremonies and featured speaker.

With 40+ attendees, the event was a clear success. This was a group of professionals coming together to learn from Matt, and from each other, about leading-edge principles and practices in the fiduciary world. Topics included technological developments in recordkeeping, participant advice, and portfolio design; legal developments in and around ERISA; and ways to help plan sponsors and participants understand the differences between the fiduciary approach on the one hand and the product-driven approach on the other. 

I found it very satisfying to see serious, ambitious people tethering their careers to the fiduciary side of the business. There was a palpable sense that we were seeing and shaping the future of defined-contribution retirement plans. Exciting stuff.

Matt is planning to hold more events like this in other parts of the country. Anyone who is interested in what it means to serve as a 3(21) ["full-scope"] or 3(38) ["investment"] fiduciary would be wise to attend. Given the information content and networking opportunities, I think you'd find it time well spent. 

We'll post information on future events as soon as we have it.

Independent Advice

Playing catch-up here with a September 14^th InvestmentNews story on the fate of a Bush-era proposal concerning the delivery of advice to retirement plan participants. Here's Sara Hansard's opening riff:

The Department of Labor is killing a regulatory change issued in the last days of the Bush administration that would have allowed brokers affiliated with mutual funds, brokerage firms and other companies that sell investments to provide investment advice to 401(k) participants.

With legislation pending in the House, and the possibility of similar provisions emerging from the Senate, it's likely that the current Congress will act on the question of independent advice. The immensity of the health care reform effort has pushed other things aside for a while, but even if it happens in 2010, and whether it's a product of Congress or the DOL or both, the rules on advice are going to change.

Meaningful legislation on independent advice would help our firm, but our support for these ideas doesn't follow from our firm's position in the marketplace. Instead it's the other way around: Our support for these ideas explains our firm's position, as we wouldn't be in this business if we couldn't do it with absolute independence. 

This is a story worth following.

Source

Sara Hansard, "Labor Department nixes Bush OK to let brokers advice 401(k) plans," InvestmentNews, September 14^th, 2009

BrightScope in USA Today

We were pleased to see our friends at BrightScope featured in yesterday's USA Today story on the high and hidden fees that plague so many retirement plans. This marketplace is changing, and very much for the better.

Fiduciary service providers, sponsors, and participants need to work hard to ensure that defined-contribution plans give participants and their beneficiaries the best possible chance of a decent standard of living in retirement. 401(k) and other DC plans aren't the only piece of the retirement puzzle, of course, but they're immensely important, and there's no reason we can't effect lots of positive change over the next few years.

Multiple-Employer Plans

Here's our latest (more or less monthly) tribute to Scott Simon's excellent work at on fiduciary issues at Morningstar.com, this time on the under-appreciated potential of multiple-employer retirement plans. Here's a key excerpt:

Some advisors to plan sponsors such as ERISA attorneys believe that many of their clients don't consider a [Multiple-Employer Plan, or] MEP and the use of a fiduciary protocol such as a professional named fiduciary because they perceive it to be too costly and something that only larger retirement plans can afford. Uh, let's see: "too costly"--as compared with what? The kind of investment options--woefully underdiversified with hidden (and therefore high) costs--that populate and plague the 401(k) plans at even many Fortune 500 companies?  

Many independent ERISA section 3(21) named fiduciaries don't depend on the existence of 12(b)-1 fees or other subsidy payments. Instead, they usually choose low-cost, passively managed funds such as index funds and asset class funds for a plan's investment options and eliminate unnecessary services that drive up costs. Retirement plans run by independent fiduciaries are priced differently, and even after the fiduciary's fees are taken into account, the total "all-in" cost is almost always lower.  

Micro-sized retirement plans can enjoy the protections and other advantages of a MEP managed by an ERISA section 3(21) fiduciary and ERISA section 3(38) fiduciary team. That way, the smallest plans can take advantage of the pricing that some of the very largest retirement plans enjoy. Although it may seem counterintuitive, independent fiduciaries are the most affordable method for delivering results-based services to plan participants (and their beneficiaries), while reducing risk to employers more significantly than any other current method offered in the retirement plan marketplace. That's why a MEP or a single employer plan in a MEP-like scenario using an independent fiduciary not only makes practical sense, it also makes real economic sense. 

In our practice, a multiple-employer plan for which we serve as a 3(38) fiduciary is a great example. Due to our breakpoints, our advisory fee is lower for each adopting co-sponsor than it would be for any of them outside of the MEP structure. These are real economies of scale for real participants (and sponsors). Good stuff.

Scott calls multiple-employer plans "the platinum standard" of fiduciary delegation, a concept that builds on his recent series on delegation per se. Read the whole column. It's excellent.

BrightScope on 401(k) Legislation

The center of gravity on 401(k) legislation has long been the office of Rep. George Miller (D-CA), who chairs the House Committee on Education and Labor and has taken great interest in issues relating to retirement security in general and defined-contribution plans in particular. 

Miller is the lead sponsor of H.R. 2989, which combines fee disclosure provisions with a requirement that investment professionals providing advice to retirement plan participants be genuinely independent. All of which sounds good to us. And to our friends at BrightScope, where Ryan Alfred has posted a comprehensive assessment of H.R. 2989's investment advice component. Here's Ryan's conclusion:

It should be the intent of the legislation to align the standard of care of financial representatives with the expectations of investors and to strengthen investor protections. If "harmonization" is to occur it needs to be the harmonization of investor expectations with the standard of care of their advisers, regardless of whether that financial firm was heretofore regulated as a broker-dealer or an investment adviser. That means upgrading all providers of investment advice to the existing fiduciary standard for investment advisers, not lowering the fiduciary protection via a new "federal fiduciary" standard. Nowhere is this case more clearly evident than with retirement plans, where a higher percentage of investors are unsophisticated and lack the freedoms they have in non-retirement accounts. These investors deserve to have access to conflict-free advice from fiduciary advisers.

We second that enthusiastically.

Assets, Liabilities, and Retirement Plan Management

In a recent issue of InvestmentNews, Fiduciary360 president Blaine Aiken opens his "Fiduciary Corner" column with this:

An investment fiduciary's duty of loyalty demands that the investor's best interests guide the decision-making process.

Moreover, close attention must be paid to the consequences of decisions, and corrective action must be taken if those decisions are not serving the investor's interests. Sometimes limited fine-tuning is all that is needed; at other times, no amount of tinkering seems to achieve the desired results, and a complete reassessment of the approach is required.

It appears to me that participant direction of retirement plan assets fits in the latter category.

Aiken goes on to note that even the (overrated, virtually unattainable) rules of section 404(c) "did relatively little to prevent participants from making poor investment selections." As longtime readers know, we too see problems with the conventional model of participant direction (see this and this, for example).

"Because a participant holds a separate account, rather than an interest in a commingled aggregate portfolio," Aiken writes, "the costs of participant-directed plans can be higher than they are for sponsor-directed portfolios." No doubt. But as we'll explain in a moment, the big picture turns on the fact that participants hold separate accounts at the individual level.

Aiken suggests that it might be "time to ask whether the whole concept of participant direction is a losing proposition for investors." That's a timely, important question. Here's Aiken's exploratory answer:

Centrally administered portfolios, like those of foundations, endowments and defined benefit plans, are less complicated. Investment fiduciaries have direct control of the process and are accountable from design to execution. The investment committee or chief investment officer, usually with the support of professional advisers and money managers, makes asset allocation decisions, directs the investments, and can change the portfolio composition as needed.

Plan sponsors and their advisers should consider whether a fundamental change in their approach for 401(k) and other defined contribution plans from participant direction to investment committee or trustee direction of the assets would better serve the best interests of the investors they work for.

Again, all of that sounds perfectly reasonable to us, but for one fact: Centrally administered portfolios would create a disconnect between plan assets (which would be managed at the system level) and participant liabilities (which would remain at the individual level).

Generally, the economic needs (i.e., risk and return objectives) of defined-benefit pension funds are relatively easy to specify, such that central decision-makers can manage assets at the system level (and participants and their beneficiaries can plan the liability side of the ledger with relative certainty as to the future payments they'll receive). The economic needs of individual account-holders, on the other hand, vary widely and unpredictably, such that central control of plan investments could/would create a disconnect between group-level assets and individual-level liabilities.

Put differently, as long as accounts balances remain individually-specified (which, after all, is pretty much the definition of defined-contribution plans), most 401(k) participants will need help with their investment decisions, but they also need the opportunity to tailor their investment programs to their idiosyncratic circumstances.

In our view, the appropriate middle ground looks like this: Participants confront a dramatically simplified choice of five or six globally diversified, risk-adjusted, pension-style portfolios (rather than a long menu of mutual funds written in Wall Street language that might as well be Sanskrit). To work outside those boundaries, they must secure the consent of their primary beneficiary (or beneficiaries), as ERISA requires fiduciaries to protect the interests of beneficiaries as well as participants.

The objectives here are (a) to make the process easy and (b) to reduce the likelihood of big mistakes. Done prudently, it can also produce meaningful reductions in plan expenses. We think this type of program solves most of the problems associated with the traditional model of participant direction while leaving room for participants, beneficiaries, and their advisors to connect assets and liabilities.

There's more individual-level risk in this type of program than in traditional pensions, but the defined-contribution regime is here to stay. The question now is how to make such plans work as well as they can.

Source

Blaine F. Aiken, "It's Time to Rethink Retirement Plans," InvestmentNews, July 12, 2009