Active management is a potential 401 (k) danger, according to sponsor guide

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A comprehensive new guide for 401 (k) sponsors advises employers to be wary of actively managed funds.

The online book, published last week by the CFA Institute Research Foundation, outlines the many tasks and considerations of a pension plan sponsor, from hiring an investment trustee to financial wellness programs. and retirement income options. Its 176 pages “focus on the basic functionality of a [defined-contribution] plan ”for 401 (k) promoters and employers who wish to start plans. The guide is written by Jeffery Bailey, senior lecturer in finance at the University of Minnesota and former senior director of benefits at Target Corporation; and Kurt Winkelmann, CEO of quantitative investment research firm Navega Strategies.

“Our intention is to generate more interest from you, which will allow you to do additional research and ultimately make better decisions,” the authors wrote. “The plan sponsor has a responsibility to provide an efficient and profitable vehicle for the accumulation of retirement wealth.

With this responsibility comes great responsibility, widely visible through the private litigation which has exploded in recent years, with the emphasis on legal proceedings concerning administrative and investment management costs.

Advice on selecting investments is needed, as most DC plan makers have little or no experience in the area and might not be aware of the extent of their fiduciary responsibilities, the authors noted. This is especially true for small employers, which represent the largest percentage of plan sponsors, they noted.

Sponsors often transfer at least some fiduciary responsibility to advisers, although employers still have a duty to select and monitor these professionals.

“Investment committees should follow a basic principle: participants should be encouraged to hold investment options that will not all fail simultaneously in adverse environments, but which are also suitable for their stage of life and their situation. risk tolerance, “the book says.

Litigation against plan sponsors has focused on three areas: expenses, investment options and alleged conflicts of interest. Expenses represent by far the largest proportion of claims, and these lawsuits have focused on “bundled service arrangements in which cross-subsidization causes the plan to pay higher fees” and those whose costs “are simply higher. that other plans pay for similar services, ”the authors wrote.

As the Ministry of Labor has clarified, sponsors and other trustees have a duty to show that the expenses charged to participants are reasonable, not necessarily the lowest cost available. Provisions that make it difficult to determine the amount paid by a registrar, for example when income sharing within mutual fund fees is used to pay administrative fees, may raise questions, the report notes.

“[M]all [employers] have tightened their oversight of spending and have become more aggressive in their periodic checks on the types and levels of fees paid to repairers, ”the authors said. “A sponsor, however, must have a clear rationale for choosing a service with higher fees than similar offerings, and the sponsor must carefully document these reasons.”

Regarding the selection of investments, they steer readers away from active management, even if they do not totally advise against it. Data showing an overall low percentage of active U.S. equity managers who have ranked in the top quartile in terms of performance for three consecutive years, around less than 10% between 2003 and 2015, shows the difficulty in identifying the skills of ‘a manager, they said.

“The first responsibility of an investment committee is to do no harm,” they said. If a committee is evaluating the possibility of including active funds in a plan menu, it should determine whether the fees are lower for passive funds, according to the report. Active funds may need more monitoring, he notes. Active managers should only be hired if they can add value after fees, if successful ones can be identified, and if the investment committee is willing to educate participants on how to use these funds, have declared the authors.

“With these points in mind, we believe that sponsors should adopt passively managed funds as the default choice for their plans,” they noted. “Unless there is a firm belief that actively managed investment options are attractive to plan members, promoters should only offer passively managed options. “

A spokesperson for the CFA Institute said in a statement that the contents of the report do not represent the views of the publication’s organization, research foundation or editorial team.

Editor’s Note: The article has been updated to include the CFA Institute statement.

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