401(k) plan sponsors may need to go old school – Carosa

Life used to be easy for 401(k) plan sponsors.

It didn’t start out that way. Nothing does. But, as water always finds the lowest level, plan sponsors could always find the most efficient alternative. Nothing spells “efficiency” like “mutual funds.”

Mutual funds represent tidy little packages presented to plan sponsors with a bow on them. Highly regulated, there’s little leeway for creative reporting for these products. As a result, plan sponsors, and the advisers they hire, can efficiently measure them, compare them, and rank them. They offer all the attraction of quantitative analysis. Rather, they offer all the appearance of quantitative analysis. But that’s another story…

This is the story of the end of that sweet sweet life. It’s been brewing for some time. It’s not quite here, but its inevitability is fast approaching. It stems from what I wrote last week: “These 401(k) millionaires are fast approaching the cusp of retirement. Yet, chances are, their assets are invested solely in mutual funds. This may soon present a problem.”

The answer to this problem is a Separately Managed Option. But, what’s good for the plan participant can be bad for the plan sponsor (see “Yes, Separately Managed 401k Account Pose Risks to Plan Sponsors, But These Steps Can Reduce Their Fiduciary Liability,” FiduciaryNews.com, May 30, 2018).

Today’s plan sponsors are a generation or more removed from the era when due diligence meant selecting and monitoring investment advisers. They’ll soon discover the easy life of mutual funds is over. Not even the lazy way out via index funds can save them. The fact is, near-retirees with large asset totals are served best with individual stocks and bonds, not by mutual funds. Plan sponsors will have to learn anew how to hire and benchmark investment advisers.

Spoiler Alert: This won’t be an easy task. Comparing investment advisers in a consistent and reliable fashion is like herding cats. It sounds good in theory, but try doing it in real life.

There are a few old-timers left, though, with experience herding portfolio managers of yesterday. Apples-to-apples comparison is the key. Plan sponsors currently rely on mutual fund reporting requirements, as aggregated by data collection firms like Morningstar and Lipper, to present this information. They’ll have to do this data collection themselves with regard to analyzing investment advisers.

The basic building blocks for this are performance reporting periods. Plan sponsors are in a position to demand all candidates present performance in identical reporting periods and in identical formats (e.g., geometric returns that incorporate both gains and income, usually gross of fees for benchmarking purposes). There’s no guarantee the data offered is accurate, so as they say, caveat emptor. There’s more, but this is a good start.

The first book I wrote (Due Diligence, Ardman Regional, Ltd., 1999) explained the process a fiduciary should employ when selecting and monitoring a professional investment adviser. It’s out of print. Perhaps that because the art of picking an investment adviser succumbed to the popularity wave of mutual funds.

At least for certain employees, that wave may be cresting.

Maybe I ought to bring that book out of mothballs.