The Markets May 1, 2023

Designing a Plan Investment Menu in Unprecedented Times

Historic rises in inflation and matching interest rate hikes have meant a heightened focus for the often staid world of investment plan design.
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Art by Lars Leetaru


In the 2010s, defined contribution investments were treated to an unprecedented market run. Not even a global pandemic, so it seemed for a time, could halt growth. That finally changed last year, when rising inflation and the commensurate interest rate hikes helped lead to 401(k) accounts falling by double digits and plan sponsors and participants looking to advisers for answers. 

For retirement plan advisers like Jim Sampson of Boston-based Hilb Group Retirement Services, the occasion served as a reminder of why his firm had been putting conservative options in plan menus like TIPS, for Treasury Inflation-Protected Securities. 

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“I remember for years and years, clients saying to us, ‘Hey, why do we have this TIPS fund in here? It’s always negative, and no one’s got any money in it,’” Sampson recalls. “I would say to them, ‘Well, if we ever have any inflation, that’s going to be what protects you.’ …. Now all of a sudden, people are saying, ‘Oh, that’s what that thing is in there for!’”

The TIPS example is something that retirement advisers operating as 3(38) and 3(21) fiduciaries reiterate when it comes to designing long-term DC plan menus. In short: Keep it simple, conservative and ready for anything.

“I would have to say, as it applies to us and the way we construct lineups, we’re pretty boring, and I’m OK with it,” Sampson says. “The more stuff that’s crazy, or new or different that we throw at people, the more we confuse them—so I’m less focused on offering people some new thing than I am in trying to get them to save more.”

Long-term planning, however, does not mean advisers aren’t adjusting to the major changes that have taken place in the market in recent years. Advisers and asset managers say they have been taking actions such as recommending more conservative target-date funds to near-retirees; adding real asset funds for exposure to things like commercial real estate and commodities; and derisking fixed-income offerings, as higher interest rates can provide solid returns for the first time in more than a decade.

Getting Real

Sean Bjork, president of Bjork Asset Management, also puts himself in the “boring” camp of investment menu design. Even so, rising inflation has prompted him to work with plan sponsors to add investments that hedge against rising costs by giving them exposure to currencies, real estate and commodities.

“Within the context of the lineup, real assets have become a little more front-of-mind after being something of a backburner item for a long time,” Bjork says.

The Northbrook, Illinois-based adviser said he will recommend funds such as a State Street real asset CIT and a Cohen & Steers real asset fund, which have exposure to investments that grew counter to the market drop in 2022. Bjork notes that these are used as sleeves within a plan for moments such as the current one, as, historically, equities and fixed income have outpaced inflation.

The real asset funds, while considered “other,” are overall pretty conservative and “not taking a bunch of menu space,” Bjork says. “Overall, we’re very boring and very vanilla. If the [Department of Labor] says that a plan should exercise extreme caution, we do not see that as an invitation to begin exploring.”

From Safe to Safer

When interest rates were low, investment menus may have included riskier fixed-income options to capture growth, notes Steven McKay, head of global Defined Contribution Investment Only and institutional management at Putnam Investments. Now, with higher interest rates, many advisers and consultants have been looking to derisk the fixed-income portion of portfolios, according to the asset manager.

“Going back three to five years, they had fixed-income strategies that were taking on a little more risk to capture yield,” says Boston-based McKay. “Now, you can get that in high-grade corporate credit, so there is a lot of derisking going on in fixed income.”

McKay does note, however, that in defined contribution investing, the long-term strategy still works best, and a hike in interest rates should not be considered a reason to overhaul your investment menu. Putnam has had a long history of offering stable value funds in DC plans, he says, as they protect against downturns in the market and preserve capital for participants.

“You need to take a long-term, historical perspective and not try and chase short-term rates,” he says.

Nearing Withdrawal

The long-term view can be hard, of course, when you are near retirement and see a double-digit drop in your 401(k) savings. Robert Massa, managing director of retirement for Qualified Plan Advisors in Houston, says during the decline in 2022, he focused on participants close to retirement age who were in shorter-dated TDFs.

“I look at the one-year trend line on those short-dated funds,” he says. “I don’t want a lot of deviation for someone that is close to retirement. … We are trying to protect that population because they don’t have that time to recover.”

Massa says plan sponsors should be aware of their population and, if they have a lot of employees at 55 or older, they should have an investment menu that can protect them from short-term market volatility. The sequence of return risk, in which a participant starts withdrawing amid negative returns, is important to consider, and an older participant may be better off in a stable value fund, as opposed to a more volatile TDF.

“What I always explain to my fiduciaries is that every participant is different,” Massa says. “You can have three participants with the same risk tolerance and three different asset allocations. The equities could be different, the bonds could be different. The key is to have the right options for each.”

Massa says he recommends educating the retirement plan committee on these issues, especially for near-term retirees, so the right options can be included in the investment menu. Just providing blanket TDF options will not customize plans to the level necessary to protect everyone.

“We know retirement plans are great and TDFs work well,” he says, “but they are not customized. I compare it to hammering a nail in with a sledgehammer instead of a finishing hammer—you can do the job, but it’s not as efficient for every person.”

The Second Journey

Sampson of Hilb says one tactic he has used for years is to offer a core bond fund-plus, which adds real asset exposure such as real estate to a fixed-income portfolio. As a plan menu generally has only a few slots for fixed-income options, that gives diversity beyond just bonds, which, as the Silicon Valley Bank collapse showed, can be devastating when interest rates rise and bonds lose value.

“I’d like to say we planned for things like [rising interest rates],” Sampson says. “We didn’t plan for exactly what happened, specifically, but we always plan for the possibility that something like that could happen. … But we at least wanted to have people have options if something like this came up.”

Sampson says he keeps in mind the financial crisis of 2008, when people near retirement were seeing losses of 40% or 50% in their retirement savings accounts.

“Oftentimes it was somebody who doesn’t follow this stuff and was probably defaulted into the option,” Sampson says. “I have a really hard time saying to somebody, ‘I defaulted you into this because we were trying to take care of you, and look how we screwed your life up.’ That is a conversation I never want to have with an employee.”

One focus area for Hilb in recent years is working with plan sponsors to trim back the investment menu options, as opposed to adding options. He believes simplifying with the right products will ultimately lead to the best nest egg for participants once they reach quitting time.

“Retirement might be the end of one journey, but it’s the start of another,” Sampson says. “My goal is to get you to the finish line in the best position possible, so when you hit the starting line of the next journey, you can be ready.”

Practice Management May 1, 2023

Why More Advisers Are Assuming 3(38) Role, Responsibility

The fiduciary model that puts plan investment decisions in advisers’ hands offers expertise and streamlining, industry experts say.
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Art by Lars Leetaru


The Employee Retirement Income Security Act Section 3(38) fiduciary designation can often mean more work for an adviser, since it assigns decision-making responsibility. It also means a conversation with a plan sponsor that likely leads to a higher fee. Even so, the industry is trending toward more advisers seeking, and taking on, the role of the 3(38) in order to manage what is increasingly complex, and important, investment strategies.

“I would tell you that we do see a trend,” says Kathleen Kelly, managing partner at Compass, which is involved in both the 3(21)—in which advisers guide on investments, but leave decisions to the plan sponsors—and 3(38) capacity.

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“Traditionally, we have thought more about 3(38) for our smaller clients, those that may have less sophistication, experience, expertise and internal resources to support decisionmaking. But in fact, we’ve seen some of our largest clients transition from 3(21) to 3(38).”

Part of the shift to 3(38)s has come amid a volatile and uncertain investment market in recent years, ranging from the COVID-19 pandemic to inflation to interest rate hikes. According to PLANADVISER’s most recent Adviser Value Survey, about 15% of DC plan sponsors had 3(38) fiduciaries, about 31% had 3(21) fiduciaries and a startling 24% were unsure of which type of adviser they had. While that puts 3(38) at the lower end of the spectrum, there is often potential to shift a client to that relationship with time, Kelly says.

A plan sponsor might first hire an adviser as a 3(21), Kelly says, but once the client becomes comfortable with the firm’s internal processes, philosophy of menu construction and monitoring, they then feel confident changing to a 3(38).

Brandon Budd, a consultant at Intellicents, agrees that clients will often consider switching to a 3(38) setup. He used the example of a client his firm had worked with for many years as a 3(21). During one of their catch-ups, Budd’s team mentioned the option of the 3(38) and shift in fiduciary duties that it would bring, among other benefits.

Budd recalls the client saying, “We take all the recommendations that you already make, we’ve hired you to outsource this and we trust you with these responsibilities We absolutely want to move into that role where you’re saying we have more protection and more liability off of our shoulders.”

Budd thinks the more that advisers have that conversation with plan sponsors, the more employers will move to the 3(38) capacity. He says Intellicents can fulfill both roles but has had more engagement on the 3(38) recently.

3(38) vs 3(21)

Kelly suggests that an advantage of being a 3(38) is that an employer does not have to be involved in a process with which they aren’t comfortable.

“They’re busy running a company, and chances are, they don’t have any expertise in investment management or investments in general,” she says. “It just makes more sense for them to outsource that decision.”

In addition, in a 3(38) role, advisers can streamline the process and make changes more quickly, says Jim Sampson, director of retirement advisory services at Hilb Group Retirement Services. As a result, employees are invested in underperforming funds for less time.

Another advantage of the 3(38) scope is that the firm accepts the full fiduciary status, which is what Budd has seen as what many employers and plan sponsors want.

“Most times when we have the conversations between 3(21) and 3(38), most employers and plan sponsors out there are trying to limit their liability as much as possible,” he says. “That’s why I think we have seen so many more go the 3(38) route than the 3(21).”

However, for employers who want full decisionmaking power, a 3(38) adviser does not offer that oversight for the employer.

“If they want to have control over the process, that doesn’t work with a 3(38),” he says. “Occasionally, clients will express their kind of fear of letting go. But they get over it pretty quick once they realize how easy the process is.”

On the other hand, the 3(21) offers employers a level of control that company leadership might prefer. For example, if an employer has an investment committee that is fully involved in researching funds and making decisions, then a 3(21) could be a preferable option.

“I spoke with a group late last year,” Budd says. “They’re in the investment business. They decided to go with somebody who was going to be a 3(21), because they wanted to maintain control of the analysis, the research—all that kind of stuff.”

However, he notes that in his experience, it is very rare that a client has the expertise and desire to take on the responsibility, and almost all of his clients have chosen to hire Intellicents in a 3(38) capacity.

Ultimately, Kelly does not believe the 3(21) versus 3(38) discussion should be viewed through the lens of advantages and disadvantages, but as which offering best suits an employer.

“It really just boils down to what is the right fit for the client,” Kelly says “What are their needs? What are their preferences? Then how do we best align our services and deliverables to what they’re seeking to achieve?”

Future-Looking

Sampson says the trend of employers preferring 3(38) designations has grown over the last five years. He attributes the change to a major shift toward the registered investment adviser model from the broker/dealer model towards the registered investment adviser model. The RIA is inherently a fiduciary model, he notes, whereas the broker/dealer model tends to be non-fiduciary.

“I think that’s where the trend is coming from,” he says. “Expert advisers who are in the RIA model, and who are experts at 401(k) plans, determined that not only are they qualified and allowed to be a 3(38), but it also just makes sense.”

He believes there are many people who might want to explore a 3(38) model, but their back office has certain restrictions in place or they simply outsource the work.

Budd also expects that brokers—individuals not acting in any fiduciary capacity—are likely to decline.

“Just from a standpoint of a sound business decision, [a client] shouldn’t be working with an adviser that’s taking on some level of liability and risk, whether that’s 3(21) or 3(38),” says Budd. “I think that will continue to accelerate, to make sure that you’re working with an expert and a specialist in this space to do what’s right for you and for your company.”

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