Why Your Clients Should Institutionalize Their DC Plans

If a road map is available, why make up a route as you go along, hoping you’ll find the way?

According to Holly Verdeyen, director of defined contribution investments at Russell Investments, one reason individuals favor the defined benefit (DB) plan model is that it offers a road map—a charted route to greater retirement success led by the employer. The interest in DB plans is more than psychological; virtually every year DB plans outdo their defined contribution plan (DC) counterparts in terms of investment returns and success generating future retirement income.

The Callan DC Index, for example, show DB plans outdo their DC counterparts by about 1% nearly every year. As Verdeyen explains, DB plans often benefit from greater access to institutionally priced investments and longer-term thinking that helps drive down costs. She feels retirement plan advisers can deliver a lot of value by helping DC clients think more like their DB plan colleagues. With their knowledge of relevant regulations, their objective professional eye, and a long-range view, plan advisers are in an ideal position to help these sponsors understand what lies ahead.

Another advantage, says Michael Swann, director of DC strategy for SEI Investments Co., is that advisers have the opportunity to build long-term relationships with plan committee members, helping them build that all-important road map for retirement.

DC plans can often be improved by realizing what pressures most often drive them off course. In contrast to the historically-tested principles behind defined benefit plans, many defined contribution plans have been shaped by retail investment marketplace trends and forces beyond the control of employers and employees.

“DC plans actually began as institutional plans, but during the tech boom of the late 1990s grew retail-focused,” says Josh Cohen, managing director, head of institutional defined contribution at Russell Investments, in his April Insights & Research Newsletter. Plans began “offering participants mutual funds they recognized from TV commercials,” he says.

NEXT: Getting down to work.

“The [retail] mutual fund industry had a great degree of influence on how DC plans were built in the decades leading up to today,” Verdeyen agrees. This became especially clear when the number of fund offerings exploded and defined contribution plans started daily valuation of participant accounts. Participants could now find their funds in the paper and monitor and manage them daily, which “led to some sub-optimal participant behaviors,” she notes.

It’s an issue that is still unfolding—with thought leaders debating the wisdom of offering actively managed single asset-class funds to workplace retirement savers. Investment lineups have drifted in a meaningful way towards passively managed funds and multi-asset class portfolios. Active or passive, most agree participants are ill-equipped to build efficient portfolios from the ground up.

But institutionalization does not mean a full move to passive investments. “It would be very rare to see a DB plan or charitable trust use 100% passive management,” Verdeyen says, calling that “a phenomenon singular to defined contribution plans.” Defined benefit plans “are going to use a thought-out mix of active and passive for different asset classes and maybe even combine them in the same asset class.”

Such thinking typifies a main difference between the two types of plans and shows advisers an entry point for getting to work. They first need to broaden the plan sponsor’s thinking in these areas.

NEXT: Advisers’ specific role.

A recent report from the Defined Contribution Institutional Investment Association (DCIIA) argues DC plan sponsors should carry a DB mindset across their operations. In terms of “institutionalizing” DC investments, this will mean broadening access to traditional and alternative asset classes, with both passive and active management of each, and potentially the unbundling of different investment services, Verdeyen says.

The DCIIA’s study “Institutionalizing DC Plans: Reasons Why and Methods How” breaks down the institutionalization process step by step, noting that by nature of the breadth of changes involved, implementation will take a while. In a later paper, which highlights the fiduciary’s role, plan sponsors are warned to seek help from an adviser throughout.

In the preliminary stage, advisers can be especially helpful for ensuring the sponsor adjusts all governing plan documents such as the investment policy statement (IPS) before implementing changes, as well as the summary plan description (SPD), educational materials and participant communications to explain what is being done.

From there on, the adviser can help keep the plan sponsor focused on its ultimate goal—maintaining an effective plan and proper plan governance, Swann says. “Institutionalization doesn’t mean the plan sponsor has removed all liability. [Plan] advisers … can help their clients remain engaged with fulfilling their fiduciary duties, and stay up to date with changes in regulations, the marketplace and industry best practices,” he says.

To foster this, “advisers can give independent evaluation when it’s needed,” he says. Additionally, they can aid in choosing investment solutions by comparing the track record and experience of fiduciary managers, he says.