A Wise Choice?
It would seem that advisers would stampede to take advantage of a new business opportunity, but that has not been the case with the fiduciary adviser role. The Pension Protection Act (PPA) opened the door to working with defined contribution plan participants on an institutional level by establishing a safe harbor for providing individualized investment advice.
Although many initially assumed that advisers would show a great deal of interest, few have actually taken up the yoke, says Robert Francis, Chief Operating Officer at National Retirement Partners (NRP). Only 16 of NRP’s 122 affiliated firms have acquired the fiduciary adviser designation, he says. There is a high degree of interest expressed by advisers in taking on the fiduciary adviser role, but most are taking a wait-and-see approach, agrees Louis Harvey, the President of Dalbar, Inc., in Boston, Massachusetts, which offers a fiduciary adviser certification program.
There are a number of reasons for the lack of enthusiasm. First is uncertainty. “Until the regulations are final and advisers and plan sponsors know what the ground rules are, they will be hesitant,” says Richard Lynch, the Chief Operating Officer of Fiduciary360 in Sewickley, Pennsylvania. Right now, says Lynch, the rules are in a state of flux due to the changeover in the administration. Proposed regulations were supposed to be finalized in January 2009, but the effective date was delayed from March 2009 to May 2009. The Department of Labor (DoL) is taking comments on the final regulations in the interim, he says, so there is a chance they will be revised.
Although the regulations do not require advisers receive certification, two organizations offer fiduciary adviser designations: Dalbar and CEFEX, which is affiliated with Fi360. Only six advisers have gone through the CEFEX program, says Lynch. At CEFEX, the fiduciary certification is performed by a qualified CEFEX Analyst, and reviewed by the CEFEX Registration Committee. Approximately 200 have gone through the Dalbar certification process, as of February 2009. Dalbar’s Fiduciary Adviser Network (FAN) includes training and due diligence documentation once Dalbar certifies the adviser.
There are also questions as to whether or not advisers who currently have conflicts have to give up the conflicted business to take on the fiduciary adviser role, says Lynch. Over the next three to five years, one of the big issues advisers will have to deal with is the risk of forfeiting revenue to comply with the rules, says Francis. Advisers, he says, are, of course, unwilling to give up current revenues.
Additionally, notes Francis, right now there is not much demand on the sponsor level for fiduciary adviser services. The employer has to subsidize the cost of services for it to make financial sense for the adviser, says Francis, and, although participants can pay the entire cost, he says, few small accounts would likely sign up, making it difficult for the adviser to make money.
The DoL may not require a certification, but it does require that advisers be audited if they are serving as fiduciary advisers and these audit requirements also may be tamping down interest. The DoL has not issued actual regulations on audit procedures, says Francis, although it has issued interpretation.
The audit process, as described by the interpretation, is very rigorous, says Francis, and has discouraged some firms from seeking fiduciary adviser status. “We have firms that, once they saw what they had to go through in the audit process, decided not to take on the fiduciary adviser designation,” says Francis. Harvey notes that the DoL has indicated that audit procedures should be determined by the auditors, and has said it will not issue specific guidance, although it has outlined broad guidelines.
Payment Schedule
Advisers who go down the fiduciary adviser route must decide how to charge for services, a decision that offers a number of possible approaches. Many advisers now are focusing on charging a flat fee of $200 to $1000 per participant. However, says Francis, unless the sponsor subsidizes the fee, it is unlikely that participants with accounts of less than $40,000 will want to pay the fee.
Another approach is to charge each participant 50 to 150 basis points (bps) to service an account. However, a basis point structure is problematic, says Francis, since the adviser has to charge the same rate to all participants. The net result, he says, is that small accounts will not be paying enough to make it worthwhile to the adviser, while larger account holders may object because they feel they are paying too much.
Advisers also can charge 5 to 25 bps across all plan assets, with all participants being able take advantage of the service. This approach appeals to advisers because they would know their annual fees with certainty, says Lynch. The problem, says Lynch, is that sponsors may not like the approach because not all participants may use the services.
Combining methods is another option. Advisers can charge a low asset-based fee across all assets and then a small per-participant amount to those participants who choose to partake in the service. The adviser then can have some assurance of an annual fee, says Lynch, and can provide generalized advice to all participants.
While advisers have been slow to adopt the fiduciary adviser role, ultimately, it will gain traction, says Francis. Some of the lack of interest also may be because retirement plan advisers are used to dealing with plan sponsors and not individuals, so it is difficult to make the leap into the retail world, says Francis. The firms that have moved into fiduciary advisory services, he says, generally have done so by recruiting a wealth manager.
Ten years from now, once the rules are finalized and advisers have stepped into the role of fiduciary adviser, it is going to be hard for sponsors to not offer the service, says Lynch. People will ask sponsors why they do not have a fiduciary adviser to help participants, and advisers will be figuring out the best way to incorporate such services into their practices.
Beyond the Fiduciary Adviser
What were 401(k) plan participants thinking? In January 2009, Hewitt’s 401(k) Index observed the largest inflow of funds—$65 million—headed into company stock, arguably the riskiest investment strategy of all at a time of significant market declines and corporate red ink. Can American workers have forgotten already that overloading on company stock is what erased the life savings of so many Enron workers?
Admittedly, January was a relatively quiet month in participant transfers, Hewitt found. The $65 million transferred to company stock represents only about 0.1% of the total balance existing across all asset classes.
Yet, it’s safe to say participants still have much to learn about retirement plan investing—that is, if they even want to learn. Pam Hess, Director of Retirement Research at Hewitt, calls company stock a highly “emotional” asset class. The same way individuals often feel safer in their own neighborhood with no rhyme or reason, “People often feel very comfortable [investing] in the company they work in,” says Hess, noting that, in study after study, participants rate the risk of company stock the same as a diversified stock fund. Another problem area: At the end of 2008, equity allocations were only 53% versus 67% a year earlier, mostly “because people aren’t rebalancing,” says Hess.
Of course, an overindulgence in company stock is not the only problem. Even before there were 401(k) plans, the industry spent significant amounts of time and money trying to teach the average employee how to be an investor. However, the passage of the Pension Protection Act (PPA) and its focus on automated program designs reveals an awareness that not every participant wants to take an active role in those investments—and that was before the nation’s economic decline hit the markets and retirement plan participants in a way that demands a well-thought-out response. That, in turn, has spurred a couple of encouraging new advice trends.
There is, for example, a renewed interest in investment advice at the plan level, from plan sponsors and 401(k) participants alike. “Advice has not run its course, even post-PPA,” says Kevin Crain, Managing Director in charge of Plan Participant Solutions at Merrill Lynch.
Currently, 275 clients are using Merrill’s Advice Access product—which it offers at no additional charge as an adjunct to recordkeeping and administration services. This is a 24% increase from January 1, 2008, to January 1, 2009. Advice Access, which combines telephone and online access with advice from Morningstar and Ibbotson, is “live” for half of Merrill’s $80 billion book of defined contribution plan business, Crain reports.
Most interesting, perhaps, is that Merrill has seen a remarkable 36% increase in participants’ use of advice between January 2008 and 2009. Today, about $3 billion of Merrill’s assets are managed through advice, says Crain, and 130,000 participants are acting on advice that has been offered. He concludes that advice will continue growing in importance as “a foundation to our retirement business’ over the next five years.”
Eric Levy, retirement business leader for Mercer’s investment advice outsourcing practice, points to a similar trend, with 12% to 18% of participants opting for advice via Mercer’s Financial Engines/Morningstar product today versus 2% with online-only advice. The program offers a “three-pronged” approach—online access, a call-in center, and a managed account solution—costing 20 to 60 basis points more than a conventional actively managed plan fund would cost.
Recordkeepers continue to add such advice programs to their platforms; most recently, ADP Employer Services announced a partnership with advice provider GuidedChoice, to provide personalized advice to the firm’s retirement plan recordkeeping clients and their participants.
Another trend centers around retirement income education. As the Baby Boomers approach retirement, there is a strong new interest in helping plan participants manage the “decumulation” stage of life and support themselves in retirement.
The opportunity to help provide guidance in this area is significant. Research from the Vanguard Center for Retirement Research indicates American workers increasingly need help to generate a sustainable income stream in retirement and to understand the variety of solutions available. In fact, among older American investors (ages 55 to 75), the survey revealed half of retired households tapped into their retirement accounts in the past year, typically as a large, one-time withdrawal. (Only two in 10 retirees are generating systematic payments from long-term accounts.)
Where retirees do seem to need help is in developing a strategy to guide their withdrawal decisions from long-term accounts. Most spenders are basing withdrawals on living expenses (37%), using a regular dollar amount (21%), or spending investment income (16%). However, 21% of spenders have no formal approach to withdrawals and another 10% use gut feelings.
Most survey respondents reported they seek to have both a guaranteed monthly income and protection of assets, while also maintaining investment control, keeping up with inflation, and having access to savings for unexpected expenses. Therefore, according to Vanguard, the survey findings suggest that many investors would prefer a mix of retirement income solutions, not a single approach, and need help balancing competing goals—a great setting for advice. —Janet Aschkenasy
Illustration by Chris Buzelli