Investing August 2, 2017

Fiduciary Rule May Force Plan Advisers Away From Portfolio Management

“The DOL conflict of interest rule poses risk to a firm if [practice leaders] knowingly allow advisers to manage underperforming portfolios for clients when a better-performing portfolio with a similar risk level is available from the home office,” Cerulli's Tom O’Shea warns.

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The latest research from Cerulli Associates suggests most executives in the advisory industry believe that home-office discretion over clients’ investment exposures will increase significantly under the Department of Labor (DOL) fiduciary rule and other competitive pressures.

Tom O’Shea, associate director at Cerulli, explains a big part of the trend comes from the fact that home office leaders, tasked with meeting new fiduciary compliance standards across potentially large groups of staffers in the field, are increasingly desperate to boost control of and visibility into day-to-day practice operations. In addition, they can now leverage new tools and strategies allowing firms to clearly identify underperforming or non-process-compliant advisers, “who can then be persuaded to use portfolios created by the headquarters consulting group.”

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“The DOL conflict of interest rule poses risk to a firm if [practice leaders] knowingly allow advisers to manage underperforming portfolios for clients when a better-performing portfolio with a similar risk level is available from the home office,” O’Shea warns. “As firms add compliance and monitoring capabilities to their rep-as-portfolio manager platforms, they are finding that [some] advisers do a poor job of steering client assets.”

Cerulli concludes that “more than two-thirds of advisers rely on themselves or their practice to help them with portfolio models. Only a minority of advisers look outside their practice for input.”

“Advisers typically look for ideas from their own adviser team rather than a home-office or a third-party strategist,” O’Shea clarifies. “Many advisers are emotionally invested in managing their clients’ portfolios and will resist their firms’ coaxing to use third-party models.”

This is only natural, O’Shea feels, “because they have worked hard to acquire certifications such as the CIMA, CFA, or CFP designations. Asking them to outsource portfolio construction and management to a third party is tantamount to questioning their purpose in life.” However, it is clear that clients themselves increasingly expect the adviser to take on a fundamentally different role than in the past—one that is less about picking stocks and bonds and more about setting/monitoring objectives and protecting outcomes.

The conclusion of the report is that “working smarter, not harder, can be elusive for many advisers … Training and outsourcing may bring productivity, and ultimately, revenue generation, up a notch.”

NEXT: Memories of 2008 could delay the trend 

While the DOL fiduciary rule reforms are in large part driving this trend, Cerulli also finds evidence that the market collapse of 2008 is also still having an impact.

“Since the market collapse, advisers have flocked to rep-as-portfolio manager programs because they want the ability to alter portfolio strategies quickly in a volatile market,” Cerulli suggests. “The added cost is a barrier to outsourcing for advisers … Advisers may achieve better portfolio outcomes and improved scalability of their practice by outsourcing money management, but most advisers hesitate to relinquish client discretion … They want the flexibility to respond to client requests without working through a third party, and they resist introducing an extra layer of fees associated with an outside consultant.”

Many advisers on the ground, according to Cerulli, believe that managing portfolios is “still the essence of what it means to be an adviser,” regardless of widespread suggestion in the trade media and from industry thought leaders to the contrary. “Some cannot imagine a scenario in which they might offload this responsibility … Some firms that Cerulli interviewed, especially independent broker/dealers (IBDs), seem hesitant to remove discretion from their advisers. This makes sense considering that the value proposition of an IBD is to allow an adviser to be independent.”

Cerulli’s data indicates that advisers for the most part want to exercise more discretion—not less—over their clients’ portfolios.

“Across the industry, advisers anticipate that RPM platforms, which accord discretion to advisers, will grow from 17.7% of managed account assets in 2016 to 22.4% in 2018,” O’Shea explains. “IBD reps anticipate the largest jump, with regional and national broker/dealer reps close behind during the same period.”

Cerulli concludes that, since the market collapse of 2008, advisers' drive toward RPM platforms may be driven more by sentiment than rationality: “While making portfolio changes in a collapsing market may be the wrong course of action, advisers feel compelled to do something to mitigate their clients’ pain of financial loss. In other words, advisers are indirectly subject to the same biases of behavioral finance that influence their clients.”

These findings and more are from the August 2017 issue of The Cerulli Edge – U.S. Edition. Information about obtaining Cerulli Associates research is available here. 

Administration August 2, 2017

Plan Design, Education Can Help Limit Participant Loans

Educating retirement plan participants about the consequences of taking loans from their account balance, as well as a few plan design changes, can limit the amount of loans taken, IFEBP says.
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It is critical for plan sponsors and advisers to educate participants about the consequences of taking out a loan, Julie Stich, associate vice president of content at the International Foundation of Employee Benefit Plans tells PLANSPONSOR. “They need to keep the money in their plan to build up money over time through contributions and the compounding of investment returns,” Stich says.

Citing data from the National Bureau of Economic Research, Stich says more than one-fifth, 21%, of participants have an outstanding loan, and within a five-year period, that rises to 37%. The employer will charge participants interest on the loan, which is typically the prime rate plus 1%, she notes. Furthermore, 86% of borrowers leave their company with an outstanding loan, and most companies require participants to repay the loan before leaving, she says. If that is the case, the Internal Revenue Service (IRS) will consider that a distribution and subject the balance to taxes plus a 10% early distribution tax, Stich says. And these loans can be sizeable, since the IRS permits participants to borrow up to 50% of their balance or $50,000, whichever is less, she notes.

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Stich recently authored a blog on the International Foundation of Employee Benefit Plan’s website about how sponsors can limit loans, titled, “Top Five Tips for 401(k) Loan Program Design.” In it, she says sponsors should explain the consequences of changing jobs with a loan outstanding. Sponsors should also only permit participants to take out one loan at a time. Stich also suggests that sponsors limit loan access to only employee contributions, not company matches, as well as the dollar amount or percent of vested balance available.

“Sponsors can also limit the reasons why a participant would take out a loan, such as for debt reduction or to pay for the child’s education,” Stich says, although the IRS does allow participants to take out loans for the purchase of a primary residence. The IRS also permits participants to take out hardship withdrawals if they are for certain reasons, including medical expenses, to avoid being evicted from their home, to pay for funeral expenses or to repair damage to their primary residence, she says.

Most sponsors charge service fees, she notes. “The higher the loan origination fee, the lower the balance,” she says. “The most common service charge is $50, followed by $75.”

Finally, sponsors can permit participants to continue to contribute to their 401(k) while they are repaying the loan, and they can set up repayment from a personal bank account rather than payroll deductions so that when an employee changes jobs with an outstanding loan, they can continue to repay the loan and avoid defaulting on it and face steep taxes, she says.

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