An Issue Brief from the Center for Retirement Research (CRR) at Boston College, “Internal vs. External Management for State and Local Pension Plans,” reveals results of an analysis that shows the number of external managers used by state and local pension plans is directly related to investment fees.
Researchers Jean-Pierre Aubry, associate director of state and local research at the CRR, and Kevin Wandrei, assistant director of state and local research at the CRR, note, “As the types of assets in which state and local pension plans invest have expanded, so have the number of external asset managers that plans use. The increase in the number of external managers used has coincided with steady growth in plan allocation to alternative investments, such as private equity and hedge funds.”
Concerns about fees and questions about the value of active management have led some large public plans to re-evaluate the size of their external management teams. The researchers cite the California Public Employees’ Retirement System (CalPERS), Wisconsin Retirement System (WRS) and Nevada Public Employees Retirement System (PERS) as examples of large plans that have recently consolidated their external management teams as part of an overall commitment to reduce investment fees, which cut into after-fee returns. In 2016, CalPERS reported that it achieved $325 million in savings in its investment office by reducing reliance on external consultants, internalizing functions previously outsourced at a higher cost and re-negotiating existing investment contracts with external managers for more favorable cost terms and improved economics.
The researchers’ initial analysis shows that the relationship between the number of external managers and the fee rate for public pensions is positive and statistically significant. Specifically, a one-standard deviation difference in the number of external asset managers (roughly 65 managers) relates to a 7-basis-point (bp) difference in the fee rate. The researchers conclude that the number of external asset managers explains roughly one-fourth of the variation in fees.
According to the report, fees could be related to the number of asset managers for two reasons. “First, using fewer asset managers translates to more assets under management [AUM] for each manager, which may give managers an incentive to negotiate reduced fee rates. Second, using fewer asset managers may increase competition between them for the reduced asset management opportunities, which could also lower fee rates offered by managers,” the report says.
Further analysis shows, however, that the relationship between the number of external managers and after-fee returns is not statistically significant. “A possible reason for this result is that plans with fewer external managers miss out on some out-performing managers,” the report says.
The researchers conclude that their findings suggest that public plans could reduce their fees by consolidating external asset managers, but, “in terms of after-fee returns, it matters which managers get cut.”
Michael Barry, president of O3 Plan Advisory Services LLC, discusses the political back and forth that occurs when administrations change, and the resulting lack of clear rules.
And here I sit so patiently, waiting to find out what price you have to pay to get out of going through all these things twice – Bob Dylan
If the Democrats don’t win both seats in the Georgia Senate runoff elections, then President-elect Joe Biden and his administration are likely to focus their retirement policy initiatives on the agencies.
It is likely, in that situation, that a Biden Department of Labor (DOL) will seek to reverse Trump administration policy in a number of key areas—e.g., the regulation of “fiduciary advice,” with a possible reinstatement of the fiduciary rule implemented under former President Barack Obama’s DOL; environmental, social and governance (ESG) investing; and the treatment of state mandatory retirement plan and automatic individual retirement account (IRA) programs.
This zigzagging of fundamental policy, depending on whether Democrats or Republicans control the DOL, raises a fundamental question about the status of agency policymaking: Is it “settled law” or just one of many (other) competing interpretations?
The Chevron Doctrine
For some time, the courts have, following the Supreme Court’s articulation of the Chevron deference doctrine, which was decided in the case Chevron v. National Resources Defense Council, deferred to agency interpretation of law when there is no explicit answer to a policy question in the statute itself.
I’m sure I’m not the first to point out there is an instability built into this theoretically neutral rule of interpretation. When a particular issue becomes politicized, the agency’s position on it itself becomes unstable.
This feature of the regulatory ecology in which we in the retirement saving business have to live and make our living is well-illustrated by the DOL’s changing positions on those three issues identified at the top—the fiduciary rule and the Employee Retirement Income Security Act (ERISA) definition of fiduciary advice, the fiduciary issues presented by ESG investing and whether state mandatory retirement plans are pre-empted or covered by ERISA.
The Fiduciary Rule
In 2016—less than a year before a new administration with an entirely different policy agenda took office—the Obama DOL finalized its redefinition of fiduciary advice, reversing a set of rules that had been in place since 1975 and, perhaps most radically, extending the application of ERISA’s general fiduciary rules to IRAs.
One rationale for this somewhat extraordinary action can be found in remarks by Phyllis Borzi, then the assistant secretary of the DOL’s Employee Benefits Security Administration (EBSA), speaking at a 2014 symposium on the 40th anniversary of ERISA, in which she suggested that there are no longer enough “people of goodwill” in Congress capable of passing legislation necessary to make needed improvements to ERISA’s fiduciary rules. This lack of people of goodwill was perhaps due to the fact that, in 2011, Democrats lost control of the House and had to deal with a divided government. As they do now.
These remarks may be viewed as a particularly robust statement of the Chevron doctrine—when democratically elected representatives can’t make “needed” changes to the rules, the agency “must” act.
This effort was struck down by the 5th U.S. Circuit Court of Appeals, which vacated the DOL’s new fiduciary rule in 2018. Subsequently, and notwithstanding a 2017 executive order from President Donald Trump instructing it to reconsider both the substance and rationale of the fiduciary rule, the DOL first dragged its feet and then, ultimately, came up with a proposed prohibited transaction, the preamble of which included a “reinterpretation” of the 1975 rule that effectively adopted most of the principles of the 2016 fiduciary rule. As I understand it, the DOL is, as I write this, under considerable pressure to withdraw that reinterpretation in the final exemption—if that exemption is finalized before a Biden DOL takes over.
It is likely (in my humble opinion) that a Biden DOL will seek to reimplement the policy pursued vigorously by the Obama DOL—a broad redefinition of fiduciary advice and fiduciary regulation of advice to IRA holders. Conceivably, it could accomplish this even by simply re-issuing the Obama fiduciary rule.
But what happens if, in four years, a Republican takes the White House and a Republican secretary of Labor effectively reverses whatever the Biden DOL accomplishes in this area over the next four years?
We’re stuck with a series of policy U-turns. Which interpretation will the courts defer to? And on what basis?
ESG
We have been zigzagging back and forth on the issue of fiduciary rules for ESG investing since at least the Bill Clinton administration. With respect to defined contribution (DC) plans in which participants choose investments—where I think this issue is particularly acute—the DOL has a problem with its basic fiduciary theory. I discussed that problem in the ESG context in July of this year.
The politics of this issue are pretty clear. Many Democrats favor certain agenda-driven investment policies, especially with respect to climate change. Many Republicans oppose them.
For those of us who simply want to do our job, it would be nice to have a clear rule. Instead, we get different interpretations making subtle—not to say obscure—distinctions that change from administration to administration. And no one is happy.
State Plans
In 2016—again, months before leaving office—the Obama DOL adopted a set of rules and interpretations designed to provide a “path forward” for state retirement programs, generally, and state mandatory auto-IRA programs, specifically. These rules were revoked by Congress through Congressional Review Act legislation in 2017—when Republicans controlled both the House and the Senate, as well as the White House.
With a divided Congress and (still) no possibility of bipartisan legislation on this issue—House Ways and Means Committee Chairman Richard Neal, D-Massachusetts, recently introduced legislation with no Republican cosponsors—it is possible that a Biden DOL will be able to implement the Obama path forward—providing, via agency interpretation, a way around ERISA coverage (at least). ERISA pre-emption has generally been the purview of the courts, but a Biden DOL would be able (at least) to provide arguments against finding that these programs are pre-empted.
In the latter regard, the Trump DOL has filed an amicus brief in the pre-emption litigation with respect to California’s program (Howard Jarvis Taxpayers Ass’n. v. Cal. Secure Choice Ret. Sav. Program), supporting pre-emption.
One assumes that a Biden DOL will—if there is time—do something to reverse that position.
Is it appropriate under Chevron to defer to an agency interpretation, when Congress previously revoked that interpretation through Congressional Review Act legislation?
*** At some point all of this descends into farce.
And if I sound harsh on the Obama and (future) Biden DOLs, I don’t mean to be. I suppose you could argue that Democrats take a more favorable view of the “administrative state,” but the real problem here is that the (in my view, inevitable) politicization of this agency has made law—or at least agency interpretation of the law—in this area unstable.
To quote Bob Dylan again, “There must be some way out of here.” But I don’t know what it is.
It may be the case that times have changed so much that we need new policies on these issues. More robust regulation of fiduciary advice. A relaxation of the rules on agenda-driven investing. A comprehensive, national automatic enrollment mandate—along the lines of Neal’s proposal. But without a bipartisan consensus on these issues, that solution will not come from Congress. And—Chevron to the contrary notwithstanding—an agency solution to these issues is proving unstable, and not in a good way.
Michael Barry is president of O3 Plan Advisory Services LLC. He has 40 years’ experience in the benefits field, in law and consulting firms, and blogs regularly http://moneyvstime.com/ about retirement plan and policy issues.
This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Institutional Shareholder Services or its affiliates.
