Investing July 13, 2015

Institutional Investors More Cautious About Alternatives

Meanwhile, advisers are more enthusiastic about alternative investments, a survey finds.
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Twenty-two percent of institutional investors surveyed by Morningstar and Barron’s financial magazine plan to allocate more than 25% of their portfolios to alternative investments in the next three to five years, down from 31% in 2013.

Meanwhile, 63% of advisers say they will allocate more than 11% of assets to alternatives in the next five years, up from 39% who expressed that level of commitment in 2013.

Additionally, 45% of institutions said alternatives are “somewhat less important” or “much less important” than traditional investments, up from 28% in 2013. Nearly one-third of advisers (31%) said alternative investments are “much more important” or “somewhat more important” than traditional investments, up from 27% in 2013.

The most popular alternative choice for institutions and advisers alike are multistrategy funds, cited by 22% of institutional investors as their fastest-growing alternative strategy and by 14% of advisers.

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“Financial advisers are increasingly enthusiastic about alternatives just as institutions are becoming more cautious,” says Josh Charlson, director of manager research for alternative strategies at Morningstar. “Advisers have a far wider range of liquid products to choose from than in the past, while institutions have become less enamored because of the high fees and poor transparency of traditional hedge funds.”

Industry Growth

Growth rates in alternatives exceeded all other asset classes, despite slowing to 12.3% in 2014 from 42.2% in 2013. By comparison, U.S. open-end funds grew 2.1% in 2014 and 3.0% in 2013. In 2014, 118 alternative mutual funds were launched, up from 89 in 2013.  The multialternative category led the way with 40 fund launches, followed by 32 launches in the non-traditional bond category and 21 in the long-short equity category.

The survey comes on the heels of a report from OppenheimerFunds stating a case for the relevance of alternatives in retirement plans to properly diversify portfolios. The survey was conducted in the spring of 2015 among 149 institutional investors and 233 financial advisers. To view the complete results of the survey, click here.

Compliance July 13, 2015

On Remand, ABB Wins Fund Change Case

In the long-running Tussey v. ABB lawsuit, a court found ABB breached its fiduciary duties, but a procedural error by plaintiffs handed ABB the win.
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On remand, a district court weighing whether fiduciaries to a 401(k) plan abused their discretion when making an investment lineup change found they did, but since plaintiffs in the case failed to prove damages using the appropriate calculation, judgement was entered in favor of the fiduciaries.

The decision was made in the long-running case Tussey v. ABB in the 8th Circuit. The 8th U.S. Circuit Court of Appeals ruled that the district court’s opinion concerning the ABB PRISM plan’s switch from the Vanguard Wellington fund to the Fidelity Freedom target-date funds shows clear signs of hindsight influence regarding the market for target-date funds at the time of the redesign and the investment options’ subsequent performance. The court added that it could not be certain that the district court would have come to the same conclusion had it used the correct standard of deference to the fiduciaries in deciding whether the change was appropriate in relation to plan and investment policy statement (IPS) terms. The appellate court vacated the district court’s judgment and damages award and remanded for further consideration using the abuse of discretion standard set forth in Firestone Tire & Rubber Co. v. Bruch.  

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The U.S. District Court for the Western District of Missouri noted several procedural irregularities in the decision to switch funds, including:

  • the strong performance of the Wellington Fund during the time period specifically identified in the IPS;
  • ABB’s inconsistent explanations for removing the Wellington Fund and mapping its assets to the Freedom Funds;
  • the fact that ABB took a substantial part of the PRISM plan’s assets and put them into an investment that was so new that ABB needed to make an exception to the IPS; and
  • Fidelity’s explicit offer to give ABB a better deal if the Wellington assets were mapped into the Freedom Funds.

Given these irregularities, “the Court is confident that ABB was conflicted when it chose to take the Wellington Fund assets and put them into the Fidelity Freedom Funds,” the district court’s opinion says. “The Court believes that the ABB Defendants knew that removing the Wellington Fund and mapping its assets to the Freedom Funds would result in persistent increased revenues to Fidelity, which ultimately would benefit ABB.” 

According to the court opinion, as a result of the fund switch, the PRISM plan sustained a loss because the Wellington Fund consistently outperformed the Freedom Funds after the mapping occurred. 

However, the district court said the plaintiffs in the case failed to satisfy their burden of proof on the issue of damages. The 8th Circuit noted that the district court previously awarded damages in the amount participants who had invested in the Wellington fund would have had if ABB had not switched funds and the participants had remained in the Wellington fund for the entire period at issue. The appellate court determined that, in light of the IPS requirement to add a managed allocation fund, the damages would more accurately be measure by comparing the difference of the Freedom Funds and the minimum return of the subset of managed funds the ABB fiduciaries could have chosen. 

Prior to making a decision, the district court had given both sides of the case an opportunity to make a new argument for damages, but they did not. The plaintiffs contended the 8th Circuit was wrong. They argued that the proper measure of damages would be the prudent alternative that provides the largest damages unless the breaching fiduciary sustains its burden of proof to establish a lower award is justified. However, the court noted they did not present what that figure would be.

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