Does removing inappropriate investment options lead to… adding inappropriate investment options? – Carosa
The push towards one-size-fits-all investment solutions might simply lead to fitting all into one size. And that just ain’t right.
The great thing about being a reporter on a regular beat means building strong relationships with insiders and thought leaders. Not only is it intellectually stimulating, but readers enjoy discovering what’s behind the curtain.
I had a chance to peek behind that curtain last week (see “Exclusive Interview: Blaine Aikin says DOL Fiduciary Rule’s ‘Lasting Impact Lives On’,” FiduciaryNews.com, April 30, 2019). When I asked Aikin about the greatest litigation risk facing 401(k) plan sponsors and fiduciaries right now, he mentioned some of the research he was doing. (He’ll be issuing a white paper on it soon. I look forward to reading it.)
Among the studies he cited was a May 2018 paper from the Center for Retirement Research at Boston College entitled “401(k) Lawsuits: What are the Causes and Consequences?”.
That got me thinking.
The paper, by George S. Mellman and Geoffrey T. Sanzenbacher, named “inappropriate investment choices” as one of the three major areas fiduciary lawsuits fall into. Lest you think “inappropriate” refers to “excessive fees” or “self-dealing,” it doesn’t. Those were the other two major areas mentioned by Messrs. Mellman and Sanzenbacher.
So, if “inappropriate” doesn’t mean high fees or conflicts of interest, that leaves only one other interpretation: performance.
Ouch!
That’s one greasy oinker to catch.
As the CRR study points out, the DOL (and the SEC, for that matter), never use results (i.e., performance) as a litmus test. Rather, regulators focus on the process. If the selection process is diligent, deliberate, and documented, regulators will generally be satisfied.
Of course, plan sponsors and fiduciaries aren’t worried about regulators. They fear the tort bar. And when you’re a big fat juicy $5+ trillion target, there’s justification in that anxiety.
Why? The DOL trusts the process may be forgiving when it comes to poor performance. Plan participants generally only complain because of poor performance. And when enough plan participants complain, the trial attorneys come calling (or is it the other way around?).
In either case, for every action there’s an equal and opposite reaction. Mellman and Sanzenbacher write “Passive investments – assuming they are reasonably managed and priced – do not pose a risk of significantly underperforming other index funds on performance and fee benchmarks.”
Umm… last I checked, they were the performance benchmark. Not that that means they represent an appropriate benchmark.
See how this game is played? It’s the ol’ “one man’s treasure is another man’s garbage” thing.
What is appropriate and what is inappropriate? And therein lies the problem: What’s appropriate today may be deemed inappropriate tomorrow. (Just ask Kate Smith.)
If Mellman and Sanzenbacher are correct, and plan sponsors seek to replace “inappropriate” funds with index funds, what happens when we experience a decade similar to the 2000s, when the major indices (and presumably their associated index funds) lagged actively managed funds? In such a circumstance, a preponderance of data would suggest passive investments are not appropriate given the market and economic conditions then existing.
Markets go in cycles. Investment styles go in cycles. Once we begin believing performance laggards are “inappropriate investment choices,” we step onto the slippery slope of the vicious circle of never-ending investment cycles.
Is your head spinning yet?
Welcome to life behind the curtain.
READ MORE:
A 3-word fiduciary rule — Carosa
The ‘Fiduciary Rule’ versus the ‘Rule of Fiduciary’ — Carosa