Bell Bottoms and Indexing

It is no secret that there is a shift towards indexing in pension plans and 401k plans.

calPERS (California Public Employee Retirement System) the country’s largest public pension announced in early 2013 they may shift more of their assets to indexing.

According to a Forbes article written in March of 2013:

Pension & Investing reported this week that the CalPERs investment committee is considering putting more into indexing after investment consultant Allan Emkin of Pension Consulting Alliance showed that at any given time, only about one-quarter of the fund’s external active managers are outperforming their benchmarks. Further, the results of the winning managers may not be high enough to cancel out the underperformance by the losing managers. He also noted that winning active managers change over time, which complicates the selection process.

In August of 2013 The Journal of Indexes published an article called New Mexico Likely to Up Passive Allocation. The article focused on PERA (Public Employees Retirement Association of New Mexico) and the potential shift to indexing. Joelle Mevi, CIO of PERA was asked the question, “What role does passive management play in the overall portfolio?”

Her response?

Actually, of our entire equities exposure, about half is passive and half is active management. I would say that the intent for the use of passive strategies has changed over the past several years. I’ve been here for four years, and we may be at a point of change. For example, our large-cap domestic equities strategies have active management, and some of our managers have been on the roster for some time. They have inception-to-date outperformance relative to their benchmark. We’ve been fortunate in the performance of these managers. Moving forward, when these contracts expire, we’ll likely transition those amounts to passive, just because we feel it’s difficult to generate excess returns in very efficient markets. We would like to spend our allocation to active management in less efficient markets.

Let’s face it, indexing is not going away.

Rex Sinquefield, the father of indexing writes in Forbes today:

This Wednesday marked the 40th anniversary of a new approach to securities investing, the index fund. At the time, the idea was revolutionary. Now index funds, which attempt to mirror the whole market and avoid the inefficiencies of active stock selection, are offered around the world. They are, by far, the most common way that individuals and institutions invest. How things change! Back in 1974, when I was an investment officer in the trust department American National Bank Chicago, our offering of the first Standard and Poor’s Composite Index Fund was actually considered un-American.  But when you think about it, the American dream of success is deeply rooted in the idea that free markets work. This is the underlying principal of the index fund.

So, who would have imagined that in the 70’s era of bell bottoms, platform shoes, mood rings and pet rocks that a revolutionary financial idea would be what it is today.

Today, according to this report published in Kiplinger’s Personal Finance, the number of index portfolios has more than tripled in the last 10 years. In half that amount of time assets of stock indices have grown 70%, while investment in actively traded stock portfolios has declined by nearly 20%.

So, the debate continues?

Active or passive?

© 2013, The Advisor Lab. The opinion in this post is that of the author and may not reflect the opinions of The Advisor Lab or any of its affiliated companies. This post is not to be construed as investment advice or guarantee of investment return.

Is It a Race to Zero?

Is It a Race to Zero?

Not exactly. However we’re definitely seeing institutional pricing and greater fund efficiency trends continue in the 401(k) universe. 

The Investment Company Institute recently updated its annual review of Services, Fees and Expenses for the universe of 401(k) plans.  As competition, lower-cost investment alternatives and downward price pressure on money market funds continue, so goes the overall qualified plan cost equation.  Ultimately, these savings accrue to the benefit of individual participants.

 

Below are several key findings from the full report.

401(k) plan participants in mutual funds tend to hold lower-cost funds. At year end 2012, 401(k) plan assets totaled $3.6 trillion, one-third of which was invested in equity mutual funds. In 2012, the average expense ratio on equity funds offered for sale in the United States was 1.40 percent. 401(k) plan participants who invested in equity mutual funds paid less than half that amount, 0.63 percent.

The expenses that 401(k) plan participants have incurred for investing in mutual funds have declined substantially in the past 15 years. In 1998, 401(k) plan participants incurred expenses of 0.74 percent of the 401(k) assets they held in equity funds. By 2012, that had fallen to 0.63 percent, a 15 percent decline. The expenses 401(k) plan participants incurred for investing in hybrid and bond funds

have fallen even more, by 19 percent and 23 percent, respectively, from 1998 to 2012.

 

The downward trend of 401(k) plan participants incurring lower expense ratios in mutual funds continued in 2012. The expense ratio 401(k) plan participants incurred for investing in equity mutual funds declined from 0.65 percent in 2011 to 0.63 percent in 2012. Expense ratios that 401(k) plan participants incurred for investing in hybrid funds fell from 0.61 percent in 2011 to 0.59 percent in 2012. The average expense ratio 401(k) plan participants incurred for investing in bond mutual funds dropped from 0.52 percent in 2011 to 0.50 percent in 2012.

Since investment product costs typically constitute the majority of 401(k) plan expenses, shifting them toward institutional shares and ETF choices seems to be making a positive difference.  As unwavering advocates for greater 401(k) efficiency, we’re encouraged that the trend seems to be headed in the right direction. You can download and read the whole report here.

When the Music Stops

The following headline in my newspaper last week regarding the [alleged] actions of a local money manager that, until it was abruptly raided by authorities, ran a hedge fund:

Investors Sue, Say they Lost Millions in Ponzi Scheme

A Ponzi Scheme is:  “A fraudulent investment plan in which the investments of later investors are used to pay earlier investors, giving the appearance that the investments of the initial participants dramatically increase in value in a short amount of time. http://www.encyclopedia.com/topic/Ponzi_Scheme.aspx

The Ponzi Scheme is named after Charles Ponzi. Even though, Charles Ponzi did not invent the scheme, he is credited with the term since he profoundly defrauded investors in the 1920’s with his promise to double investors’ money in 90 days or less.

Sadly, we know how the story ends. Eventually, the SCHEME crashes leaving investors broke while the courts figure out how to divest the huckster’s mansions, cars, bank accounts, and all the stuff that greed can buy.

The more recent Ponzi Schemes of Bernie Madoff and Allan Stanford should remind investors that if the returns sound too good to be true…there is a high probability they are. Madoff and Stanford bilked over $25 billion from investors with the grand lie that there are high returns with low risk.

One only has to do a Google search on the term “hedge fund fraud” to confirm the number of Ponzi Schemes perpetrated on unsuspecting investors leaving them broke, angry and financially ruined.  In the story that followed headline referenced above, the lawsuit claims that the money manager purported to deliver returns of 432% from 2006-2011. Keep in mind that the S&P 500 index during the same time frame returned 2.26%.

And, no, 432% is not a typo.

It’s only 191 times more than the common stock benchmark for the largest 500 publically traded companies in the United States during a time period where equities melted down following the credit debacle. Seems reasonable, right?

Naturally, investors greedily piled on with the hopes of returns without risk.

So, if you are ever approached by a friend, relative, money manager, business associate, financial advisor etc. singing the praises of some hot investment…please keep these core principals in mind:

• There is NO FREE LUNCH on Wall Street. Risk and Return are RELATED.
• PAST PERFORMANCE is NOT a GUARANTEE of future results. I know this is on the bottom of every fund fact sheet, prospectus, etc. but it is there for a reason…it is TRUE.
• It is next to IMPOSSIBLE to FORECAST or PREDICT the Market.
• BEWARE of anyone that tells you that they have a ‘proprietary system or black box’ methodology of investing.
• Don’t investing in anything that you cannot measure. You should be able to BENCHMARK or PROXY your investments with a relative KNOWN index.
• COSTS and RETURNS are correlated.

Have a great weekend.

© 2013, The Advisor Lab. The opinion in this post is that of the author and may not reflect the opinions of The Advisor Lab or any of its affiliated companies. This post is not to be construed as investment advice or guarantee of investment return.

Persuasion is Sushi

Persuasion is Sushi.

Try saying that 10 times, fast.

We’ve discussed here before how nothing happens until something gets sold. And the first “sale” that transpires is that of an idea or concept. The essence of Persuasion is more craft than science. A lifetime of honing our Persuasion skills will likely reflect they are something we can improve but never fully master. That doesn’t mean we shouldn’t continually pursue their perfection.

So, when we come across punchy points on Persuasion, we’ll endeavor to share them. Here are several outstanding bullet points from Kevin Daum’s recent article entitled “7 Things Really Persuasive People Do:”

1. They Are Purposeful
2. They Listen … and Listen … Then Listen Some More
3. They Create a Connection
4. They Acknowledge Credibility
5. They Offer Satisfaction
6. They Know When to Shut Up
7. They Know When to Back Away

A brief commentary on each point is available through this link.

Perhaps Persuasion mastery follows the path of the sushi Shokunin: true masters spend a lifetime pursuing improvement, all the while understanding complete mastery is simply unachievable.

If that conundrum intrigues you, get this fascinating documentary in your weekend video queue. You don’t have to like sushi to be captivated by the extraordinary story of Jiro Ono, arguably the greatest sushi chef alive today.

The journey is the destination.

The Advisor Lab in Plan Adviser Magazine

This past month Plan Adviser Magazine wrote an article called Looking Deep Into a Plan. The article focuses on retirement plan benchmarking and what tools are available for plan sponsors and advisors. As most of you are aware, the DOL 408(b)(2) requirement mandates plan sponsors to determine if the fees they are paying in their plan are reasonable or not. Benchmarking is crucial in understanding these fees.

I am excited that The Advisor Lab’s Retirement Plan Diagnostic Report was featured in the article.

The Advisor Lab’s Retirement Plan Diagnostic benchmarks plans against other plans of similar asset and participant size (+/- 10%) using the most current Form 5500 data from more than 1.1 million plans, with the adviser providing the fund names or symbols to pull in Morningstar and Lipper data.

Our very own, John Resnick (Director of Advisor Development) was quoted in the article:

In addition to commissions and fees versus a plan’s peers and industry, The Advisor Lab tracks investment return, plan participation and plan utilization, along with asset class diversification. According to John Resnick, director of advisor development at The Advisor Lab in Philadelphia, “Our reporting helps advisers clarify not just an overall dollar amount but who is getting how much and for what.”

The Advisor Lab’s Retirement Plan Diagnostic report draws from DOL and third-party investment research data and enables advisers to simply input the plan name and current investment names or symbols to generate a 12-page report in about 10 minutes. “Advisers tell us it helps them simplify the complex [data] and communicate meaningful metrics in an easily-understood format,” says Resnick.

I am proud to say that The Advisor Lab’s Retirement Plan Diagnostic Report (as well as the entire suite of The Lab’s retirement tools) have been instrumental in helping plan sponsors and advisors gain greater understanding of the fees that are in a retirement plan.

You can read the article in its entirety by following this link.

Fee Disclosure: Are You an Optimist or a Pessimist?

A few months ago, we talked about the “Glass 2/3 Full” perspective in the retirement plan opportunity arena.  Now, finally, come the waves of Fee Disclosure on the proverbial 401k beach.  And some folks are already lamenting the fact that the new requirements haven’t gone far enough.  Or that perhaps the current loopholes will be big enough to enable those pursuing fee obscurity to make those committed to fee transparency seem “more expensive.”

Lou Harvey from Dalbar says the new rules are “a joke.”  He thinks they’ll make explicit RIA fees seem out of line to Participants because non-RIA’s can still play the shell game, burying fees in fund expense ratios.

While we share some of Mr. Harvey’s  lament, we don’t share his general pessimism.  We think the contrast between the “fee obvious” and “fee obscure” camps will be more stark than ever. And now, finally, the conversations are really starting to heat up.

Employers operate in a world of balance sheets, income statements and costs of goods sold.  They intuitively know better than to think they can get something for nothing or valuable advice for “free.” If you’re out there helping Plan Sponsors realize that “baking in” service provider and advisor fees in fund expense ratios is purely an attempt to skirt the spirit of Participant Fee Disclosure, then you can embrace the current market conditions with great optimism.

If you’re so worried about the fee you’re charging that you ‘d rather make it difficult to understand, then there’s a much bigger problem.

Fair and Reasonable fees withstand scrutiny. As such, they can and should be clearly stated without reservation.  Anything short of that starts to look like a shell game.

Stay tuned for an upcoming Sherpa Webcast on the subject, including some behind-the-scenes email confirmation that Proprietary Providers are asking Plan Sponsors to help them hide the truth.

Have a great week,

Mac & John

5 Reasons to Pretend You’re Not Home When the Multiple Employer 401(k) (MEP) Salesman Comes Calling

There is lots of chatter, aka selling going on regarding MEPs.  For the record–I am not an attorney (and never played  one on television) but this fellow Sherpa had the opportunity to talk to a few ERISA Attorneys (you know those folks who know a little about the law) regarding Multiple Employer Plans. Mmmm….

FIVE REASON TO PRETEND YOU’RE NOT HOME WHEN THE MULTIPLE EMPLOYER 401(k) (MEP) SALESMAN COMES CALLING

5.    Uh, Bernie is that you?

Post-Madoff it’s a little hard to believe (okay maybe it’s not so hard to believe) that folks are promoting accounts where essentially unregulated and unregistered entities (i.e., record keepers) have primary responsibility for the allocation of assets to many unrelated employers. If one adopting employer sends contributions that are not properly identified it may be difficult for even the most astute and well meaning, record keeper to adequately the source of the deposit. Needless to say, there is a much greater potential for misallocation.

4. Mary Schapiro on line 2.

Did you say Madoff, unregulated and allocation all in the same paragraph? The SEC has opined on several occasions that MEPs are subject to both the Securities Act of 1933 (only single employer plans are exempt) and the Investment Company Act yet we are unaware of any that have registered.

3. The last guy who called me top heavy would have been 35 yesterday.

Unfortunately, because MEPs are treated as single employer plans for many plan qualification requirements, if any one employer fails to meet any requirements that are tested or required on an employer-by-employer basis the entire MEP fails to meet the qualification requirements. For example, Treasury regulations specifically provide as follows: “… if twelve employers contribute to a multiple employer plan and the accrued benefits for the key employees of one employer exceed 60 percent of the accrued benefits of all employees for such employer, the plan is top-heavy with respect to that employer. A failure by the multiple employer plan to satisfy section 416 with respect to the employees of such employer means that all employers are maintaining a plan that is not a qualified plan.” Nuff said?

2. Sure we have something in common but is it really enough.

There is a lot of chatter about whether a MEP sponsored by multiple employers who act as independent co-sponsors, so-called open MEPs, require that each adopting employer have a common nexus or commonality. While there does appear to be a statutory basis for open MEPs, the Department of Labor (“DOL”) has not yet opined on the matter and given the expectation that the DOL will speak to this issue in the near future.

1. I thought that you said I couldn’t be sued.

 These may not be the most famous “last words” (Custer’s last stand?) but they are probably right up there. Despite the clear ability to delegate fiduciary responsibilities in a MEP as in a single employer plan, many practitioners are very skeptical of the claims made by MEPs that they allow an adopting sponsor to avoid all fiduciary responsibility. Instead it does seem likely that adopting employers retain some residual fiduciary responsibility to monitor the MEP. Thus, until the DOL opines on the subject, it appears that the best practice is for adopting employers to assume that they have some fiduciary responsibility to at the very least monitor the plan holding their employees nest eggs.

© 2012, The Advisor Lab. The opinion in this post is that of the author and may not reflect the opinions of The Advisor Lab or any of its affiliated companies. This post is not to be construed as investment advice.

Variable Annuities and 401(k) Plans

I grew up in a house with three brothers…yes three rambunctious, ornery, funny, fighting brothers.  My mom, Gussie (yes, that’s right Gussie) ruled the house with a tough as nails, take no prisoner-discipline and was never shy  in reminding us who was boss (even when we were teenagers).  I still believe she would have been a heck of a CEO or entrepreneur with her no b.s. style of management and motivation.  Her farm upbringing and the fact that she was the oldest girl of 9 kids served her well.

On one particular Sunday we misbehaved in church embarrassing her.

Clearly, we broke one of her cardinal rules which was don’t act up and bring attention to yourself.   She gently (yeah, right) reminded us that church was not the time or place for such foolishness.

For some reason when I read the linked article below from Forbes called Why Variable Annuities Have No Place in Your 401(k) Plan I heard the words of Gussie and her behavioral expectations of what was appropriate.

Variable Annuities in 401(k) plans?

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© 2012 The Advisor Sherpa.  The opinion in this post is that of the author and may not reflect the opinions of The Advisor Lab or any of its affiliated companies.  This post is not to be construed as investment advice.

The Glass is 2/3 Full

The Investment Company Institute (ICI) and Deloitte recently updated their 2009 401(k) fee study with even more data points among 525 plans surveyed in 2010. Expectedly, the 38-page report is chock-full of enough yummy statistical goodness to satisfy your inner math nerd.

Sifting through all the findings, these graphs, separated by 17 pages, jumped out at me like gold nuggets in the pan:

As if common sense and procedural prudence weren’t enough justification for plans to have a current, objective benchmark and competitive review completed, those that did saved fees as a result. The longer the time since last competitive review, the greater the savings.

How many plans are likely candidates?

Since plans reviewed even within the last 2 years are paying lower fees, likely candidates could really include every plan.  However, let’s assume we’re looking only at the “3 years or longer” category.

So, that would be . . . . . just . . . . .68%!

Astonishingly, 2 out of 3 plans haven’t been competitively reviewed [much less objectively benchmarked] in 3 years or longer. If you’re providing that opportunity to plan sponsors, your glass is at least 2/3rds full.

And, with $4.5 TRILLION in employer-sponsored defined contribution plans at year end 2010, it’s statistically a bottomless glass.