It’s not easy being an adviser in today’s retirement marketplace. On top of existing pressures, the Department of Labor’s fiduciary rule means that advisers can expect additional scrutiny over fees. So how can you prepare for these industry changes?
One mistake is to assume that you can reduce fiduciary liability by foregoing active funds for the lower-cost provider. In fact, that strategy can have the opposite effect.
The Employee Retirement Income Security Act of 1974 calls for plan fiduciaries to take a wide variety of factors into account when making fiduciary decisions, not just fees. Furthermore, selecting only passive funds automatically precludes investors from the possibility of achieving superior returns over a benchmark, which carries its own set of risks — especially in bear markets.
There are five guiding principles that could help you protect your practice when considering options for retirement plan lineups and investor portfolios, according to a recent paper by Alison Douglass, a partner at Goodwin Procter, titled, “The Misperception of Fiduciary Risk and Active Management in DC Plans: A Legal Perspective.”
Here we describe common misperceptions of fiduciary risk, and contrast with the Douglass’ guiding principles.
MYTH #1 Poor investment performance is an indication of fiduciary imprudence.
REALITY It’s about the process.
- Actions are judged on the quality of decision making and circumstances at decision time
- Fiduciaries should not be judged solely on results
- Decisions do not have to be perfect, but the process must be prudent
MYTH #2 The lower cost option is always the safer (and better) option.
REALITY Fiduciaries should focus on the value-for-cost proposition.
- Consider available alternatives, and understand key dimensions such as investment type, asset class, management strategy, and cost
- Fees cannot be evaluated in a vacuum
- ERISA does not require fiduciaries to “scour the market” for the cheapest option available
MYTH #3 There is one right method to select investments for all plans.
REALITY There is no one-size-fits-all approach.
- Fiduciaries are entitled to consider participant preferences
- Consideration may be given to participant age and level of investment sophistication
- Fiduciaries may consider whether certain investments may encourage participation or higher savings levels
MYTH #4 One way to protect participants is to limit investment options.
REALITY Range of choice and strategies can be appropriate.
- Participant choice plays an important role in defined contribution plans.
- Safe Harbor guidelines help to encourage making available a broad range of investment options
- Safe Harbor guidelines encourage use of investments with different risk and return characteristics
MYTH #5 Follow the herd to limit liability.
REALITY Fear-based decisions fall short of prudence.
- Fiduciaries are required to act for the exclusive benefit of the plan’s participants and their beneficiaries
- An ERISA fiduciary’s loyalty is to its participants, and its decisions should not be motivated by its own self-interest
- Fiduciaries should make informed choices, and do so for the right reasons.
As Douglass noted, fiduciary standards do not favor the use of either actively or passively managed strategies. We believe that much of the apprehension that some advisers and consultants feel about placing retirement assets in active strategies is rooted in misunderstanding or misperception of fiduciary standards. The most appropriate fiduciary course of action is to have a prudent process that supports all decision-making.
In our view, knowing these myths and related principles could help differentiate and maximize the value you bring to your clients.
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