Is it time to outsource your DC plan?
If you are an investment committee member for a defined contribution retirement plan, you may feel the weight of responsibility for making decisions about tens or hundreds of millions of dollars of other people’s money.
In my experience, (and I first started meeting with investment committees of defined contribution plans in 1985) many committee members are uncomfortable when asked to make investment decisions. The main reason is that this is not their area of expertise, and they know it.
Gaining sound investment expertise is not easy. Not only is the amount of money more significant today, but also the investment landscape has changed dramatically. Thirty years ago, investments consisted primarily of stocks, bonds and cash. The stocks were mainly U.S. domestic and, almost exclusively, large cap companies. Bonds consisted of U.S. government securities and high-grade corporate bonds. High yield was just a gleam in Michael Milken’s eye. Asset-backed securities, mortgage bonds, liquid alts, emerging markets, target date… well, you get the idea; they did not exist either.
Today, globalization and the sheer number of investments available to both retail and institutional accounts can be overwhelming for even the most knowledgeable committee member. The parallel development of complex investment analytics and risk measures can make the job that much more difficult. Add to this mix, increased government regulation, fiduciary complexity and the potential for litigation.
It is unsurprising that investment committee members may be out of their comfort zone when faced with decisions that industry professionals have to consider. Even if committee members have sufficient knowledge, the time required to deal with these decisions may problematic.
How do we address this issue? The best approach may be to share the burden with others.
Outsourcing takes off
Investment committee members for defined benefit plans, foundations and endowments began recognizing the need to share their responsibilities a few years ago. Many decided to turn over or outsource the selection of managers and the related monitoring to industry professionals for either all or a portion of their portfolios. Based on the continued growth in outsourcing these functions, committees appear to be happy with their choices. A recently updated study predicts that institutional outsourcing of investments will reach $739 billion in the next three years.1
This trend is expanding now to the defined contribution (DC) world. With DC plans becoming the primary and often only retirement plan offered to employees, the stakes for fiduciaries are higher than ever. While outsourcing will not be appropriate for every organization, many committees may find this to be the right choice for them and their plan participants. In a recent survey, 36% of plan sponsors indicated they either already outsource the investment decisions for their DC plan or are considering doing so.2
Global Revenue Opportunity ($M)1
How it works
In the retirement world, there are two approaches that committees can take in using a fiduciary consultant. They can have their consultant be a fiduciary by making recommendations under ERISA 3(21)(a) and reserve decision-making to the committee, or they can outsource or delegate the investment decision-making process by giving the consultant discretion to manage, buy and sell plan assets under ERISA Section 3(38).
An ERISA 3(38) manager takes discretion for investment decisions such as retaining or firing investment managers or funds available through the plan. In addition, the consultant will negotiate investment manager agreements, where needed, and oversee the transfer of monies from one investment manager to another to ensure accuracy and timeliness. If desired, the consultant can create manager-of-manager structure3 that simplify decision-making for participants. These manager-of-manager structures often are better diversified than portfolios created by the typical participant.
1 Exhibit 9, page 11 of The Complete Firm 2013: Competing for the 21st Century Investor, Casey Quirk, February 2013.
2 2014 Defined Contribution Survey, Towers Watson.