New Frontier
The title of the cover story for the first print edition of PLANADVISER back in 2006 was the short but rather ominous-sounding phrase, “Now What?”
The question alluded to President George W. Bush’s signing of the Pension Protection Act of 2006 (PPA). Given the absolute boon to the defined contribution (DC) retirement plan industry that automatic features and other elements enshrined by the PPA have become, this may be hard to remember, but at the time, a fair number of advisers were asking whether certain aspects of the act could rob their business model of its traditional value of providing investment advice.
For many of them, it may have. At the time, retirement plan advisers were still commonly focused on building investment menus, convincing would-be participants to start saving, and then training them about the basics of risk mitigation, asset allocation and regular rebalancing. Target-date funds (TDFs) and managed accounts were still something of a novelty, and defined contribution plan sponsors were reluctant to implement automatic plan designs.
The PPA changed many of these dynamics, forcing “traditional advisers” to evolve in a pretty remarkable way: to focus more on plan design, fiduciary responsibilities, fees and outcomes.
“We know that in the last 10 years or so, the advisory community has been quite successful in its effort to evolve, moving away from being purely investment experts to embrace the role of a retirement plan design consultant,” says Jordan Burgess, a long-time Fidelity executive who now oversees defined contribution investment only (DCIO) sales for Fidelity Institutional Asset Management in Boston. “They have not had much of a choice, and so today we still see advisers who are critically important to the success of retirement plans. While they are still successful, there is no denying they are engaged in different work than they used to do.”
Citing his firm’s latest Plan Sponsor Attitudes Survey, Burgess says it’s no surprise advisers have remained relevant even in a world where employers can automatically sweep their employees into savings plans and push them into professionally managed portfolios that more or less take care of themselves. “Advisers who are positioned for the future have moved well beyond the investment recommendations,” he explains. “They are knowledgeable and proactive on plan performance, plan design consultation, managing fiduciary responsibility, and minimizing and tracking costs. All of these things are very high on the list of demands from the plan sponsor, post-PPA.”
Fiduciary Advisers Have Excelled
This shift in client demands and expectations has only increased opportunities for advisers. In 2009, once all provisions of the PPA had been implemented, 62.5% of all plans worked regularly with at least one adviser or consultant, according to the 2010 PLANSPONSOR Defined Contribution Survey. Today, the number is 71.7%, with some truly impressive growth figures for advisers in the less-than-$5 million markets. In fact, that statistic has risen considerably in just the past two years, with 65.9% of small/micro plans working with an adviser in 2015 compared with 52.0% in 2014, according to the PLANADVISER Adviser Value Survey in each of those years.
Fiduciary advisers in particular have distinguished themselves in the last decade, research shows. According to the 2016 PLANADVISER Adviser Value Survey, plans with fiduciary advisers are substantially more likely to have employer matching contributions available to employees; are more likely to have nonelective or profit-sharing contributions; and are more likely to have automatic enrollment in place. The same survey shows plans with a fiduciary adviser are far more likely to have automatic salary deferral increases in place—43% of plans with a 3(38) fiduciary and 37% of plans with a 3(21) fiduciary—versus a mere 14% for those lacking fiduciary advice.
And the list goes on. Plan sponsors with a fiduciary adviser are also much more apt to have a formally adopted and regularly reviewed investment policy statement (IPS)—i.e., 83% for 3(21) clients and 88% for 3(38) clients versus 58% with a nonfiduciary adviser. Further, they have higher balances on average than their counterparts lacking fiduciary advice, at about $92,000 for fiduciary adviser clients and $76,000 for nonfiduciary adviser clients. They are more likely to review investment options on a quarterly basis (54% vs. 30%) and much more likely to have all-in average expense ratios below 50 basis points (bps)—33% and 39% for 3(21) and 3(38) clients, respectively, versus 26% for nonfiduciary advice consumers.
Burgess notes that, thanks in part to Department of Labor (DOL) rulemaking but also to the increased prevalence of defined-contribution-plan-focused litigation—not to mention plan sponsors’ own increased desire and willingness to institute best practices to drive better retirement outcomes among an aging work force—“the fiduciary element has evolved to become probably the most important aspect of this whole conversation.”
“In our polling, we find almost 40% of plan sponsors say addressing fiduciary exposure is their top concern in hiring an adviser, versus 24% just last year,” Burgess says. “This is pretty amazing to see such a rapid change, but we feel it is no surprise that we now see 70% of advisers telling us they’re willing to embrace the fiduciary role. It’s obviously a big finding, and it has big implications for the next decade or even longer.”
The great news for advisers working in the DC space is that satisfaction stands at an all-time high, according to Fidelity polling. More good news: Advisers are perceived by the vast majority of clients, also an all-time-high number, to be delivering significant value vs. costs. Yet at the same time, the percentage of plan sponsors looking to switch advisers is also a record high.
“This series of facts is even more remarkable when we remember that, back in 2013, the desire to change advisers was at its lowest point we have measured at Fidelity, with just 13% of sponsors we surveyed saying they were actively looking for a new adviser,” Burgess says. “Now it’s jumped way back up to 23%, yet there is also this perception that advisers are doing a better job than ever. What the heck is going on here? One of our hypotheses is that, given all the litigation pressures and DOL’s work, sponsors want to make sure they’ve done full due diligence on their adviser. They want to have the documented process and to be able to show on demand that they’ve crunched the numbers.”
The Evolving Role of Advisers and Providers
Carolyn Johnson, CEO of insurance solutions for Voya Financial in Windsor, Connecticut, has in recent years seen advisers “moving back to a true advisory model.” She says this is “very encouraging from the perspective of plan participants and DC system outcomes.”
“I’ll use my own area of concentration as an example, but this conversation around shifting fees and service applies more widely as well. Annuity products have traditionally been structured to pay a commission, and that has really created a need to have things such as surrender charges and other fees that can make plan sponsors uncomfortable,” she says. “They are not just arbitrary expenses, of course, in that the annuity company is fronting a commission to the adviser, so they need to promote longevity in that product, and so a surrender charge is the natural answer. As you move to more of a true advisory model for all this, you’ll see more demand for options that are willing to be innovative and with very short or very low surrender charges. This will not exactly be easy—it’s a whole new territory for annuity providers and advisers alike.”
Johnson says Voya and the investment product providers with which the company competes are all hard at work building out this next generation of products. “Whether talking about annuities or other products, implementation of the fiduciary rule will create really strong demand for a new way of thinking, and advisers will absolutely have to respond accordingly. Then, as now, they will be in an important sense the gatekeepers for a lot of these products,” she predicts.
Speculating further on the role of “true fiduciary advisers,” Johnson says the internal industry conversation has been very rich regarding the DOL fiduciary rule reform that is being implemented this year and next—essentially broadening the number of advisers to be considered fiduciaries under the Employee Retirement Income Security Act (ERISA). “It’s been an ongoing conversation, and it’s taken a while for the rule and its impact to marinate. Our current thinking is along the lines of understanding that there is going to be a lot more disclosure, and there will be new processes associated with the new rule and its transparency requirements.”
These new disclosures and processes will unavoidably increase the cost of compliance, but there is also much in the rulemaking to encourage career advisers, she feels.
“It levels the playing field in some important respects, and it gives us confidence about how our products are being used, compared, discussed and recommended in the marketplace,” Johnson says. “We are optimistic, in that respect, despite the burden of additional cost and process. Complying with the rule will be all about getting everyone on the same page with regard to what the customer has been presented with during the sale of a product, and making sure the service value aligns with and even exceeds expectations.”
In terms of more specific predictions for the coming years, Johnson, among others, suggests “very few providers have as yet come out with clarity on what they are going to require with regard to product, with regard to compensation and process.” But she thinks most of them will “look to be more consistent in terms of compensation that they pay. Some brokers have told us they expect the compensation paid to advisers or reps across an annuity product lineup will all be the same moving forward, for example.”
“That tends to be the general theme we’re hearing from the broker/dealers [B/Ds] at this point, but very few have told us actually what that compensation level may be,” Johnson warns. “So that leaves the big questions yet to be answered. Will gross compensation be lower than it is now, and, therefore, will providers have to change their products to address this? Will compensation be pretty much the same, just packaged and disclosed a little differently? Or will it be even higher? I expect that, by the end of 2016, we’ll start hearing more and more from the distributors, and it will be time for advisers to make their final decisions. Again, I focus on annuities, but I know this is a similar dynamic to the wider marketplace changes that are being contemplated in response to the DOL fiduciary rule and other pressure points.”
The Past and Future of Compensation
Clearly another one of the big stories of the last 10 years has been centered around fees—defining and disclosing exactly what and how people pay to access investments, whether through defined contribution plans and individual retirement accounts (IRAs) or otherwise. According to Jake Gilliam, senior multi-asset-class portfolio strategist at Charles Schwab Investment Management in Cleveland, the trend is partly tied to the fee disclosure regulations adopted in the last decade under ERISA—think 404(a)(5) and 408(b)(2)—but it is also a result of some pretty fierce competition among providers and the increasing sophistication and professionalism of the retirement plan community itself.
“End users today are constantly demanding better products at better pricing,” Gilliam says. “The pressure, quite frankly, has served to elevate the work of providers to the point that Charles Schwab has just rolled out to the market a passive target-date fund that is 8 basis points all in, with no minimum investment. That would have been pretty much unheard of 10 years ago.”
Thinking ahead another decade, Gilliam agrees with speculation that fee-focused competition, data technology and various other forces will continue to fundamentally reshape the way people think about investing—and about leveraging or not leveraging advisers.
“For example, at Schwab we believe we will see lasting interest in so-called ‘collectives,’ especially collective investment trusts, or CITs,” Gilliam says. “We will also see much more goals-based, customized investing. These have been important areas of development in the last decade, and they will continue to be so. Mutual funds will continue to play an important role, but there are other approaches that are increasingly a part of the plan advisers’ and plan sponsors’ toolbox.”
Anthony Domino Jr., managing principal of Associated Benefit Consultants of Rye Brook, New York, should also be counted among those optimistic that advisers will continue to develop their fee approaches for the better—as they have over the last decade. But he is also plenty concerned about the fee-focused litigation that has increased in intensity seemingly every year since the launch of PLANADVISER and the creation of the current advisory paradigm—reaching a veritable fever pitch in 2016.
“The thing to keep in mind as we sort all of these challenges out is that we’re only facing these hurdles as an industry because we allowed ourselves to grow somewhat complacent [about] improperly buried fees and questionable marketing/sales relationships,” Domino says. “As an industry, we have allowed an over-complication of what it costs and how you pay to invest in a retirement plan. It’s simply not a good thing that it’s still so hard to figure out exactly what a given participant pays in fees and costs.”
Domino suggests that in the last 10 years we “have seen the 401(k) plan, from the perspective of the adviser, really evolve in the wake of the PPA and become these very nice, neat little machines that just chug away. Money goes in on a regular, automatic basis. More and more people are automatically swept into the plan, and ideally account balances grow, not just because of the participant and employer contributions but also because of markets increasing over time. We absolutely have to reflect this in the way we charge fees and think about how clients pay us, and we absolutely have to be proactive as we do this.”
This is a clear takeaway from the glut of litigation already spoken about; it is more or less the exact same line of argumentation running through many of the recent 401(k) fee lawsuits.
“You have plans that have grown to billions in assets charging the exact same asset-based fee as participants were paying when the plan was much smaller,” Domino says. “The plaintiffs want to know, what additional value was being delivered for all this additional money being paid out by the plan? And if there was no additional value being extracted, why didn’t the fiduciaries pick up the ball and act to renegotiate fees? It’s that simple. The participants see their billion-dollar plan paying the same asset-based fee that an individual investor could get, and they get mad, as well they should.”
Taking it all together, Domino says, “Beneath all of the litigation and beneath the DOL’s fiduciary rulemaking is a movement to shake loose the casual investment adviser and insurance agent who did one or two 401(k) plans once a year. This is becoming an area where only the true specialist DC advisers can survive—both on the investment side and on the plan design side.”
Keeping the Participant Front and Center
Asked to consider the next 10 years of advising, State Street Global Advisors’ Megan Yost, Boston-based head of defined contribution participant engagement, agrees wholeheartedly with the assessment that demands are increasing and that more-skilled defined contribution plan advisers will thrive, as nonspecialists wither in the space.
“In terms of specific recommendations we think are absolutely critical for the next 10 years, first and foremost we need to see the automation of the rolling of savings from one employer plan to another via new collaborations among recordkeepers, investment companies and even advisers,” Yost says. “Tied to this, we should see the simplifying, standardizing and digitizing of enrollment and roll-in application paperwork, and it should be made very easy to find and access such documentation.”
Beyond these particular points, Yost says, there is “going to be a lot of innovation that is hard to imagine right now—where we will be 10 years out is really hard to predict with any confidence.” One thing that is clear: She feels providers and advisers “have [substantial] work ahead of them when it comes to improving end-user choice architecture.” In the last decade, this has only just started to play out through the simplification of investment menus and the connection of retirement savings to the more holistic financial picture, she says.
“If you think back 10 years, Facebook didn’t really exist. We didn’t have iPhones. The whole world was different in some important respects, so I think there will obviously be a tremendous amount of change going forward,” Yost adds. “We are very encouraged by the work the industry is doing—there is so much potential to really help make a difference for participants and get them retirement ready. Advisers are in the driver’s seat.”
Art by John Hershey