USA – DISTRICT OF COLUMBIA Trends and Developments Contributed by: Sanford Heisler Sharp McKnight, Sanford Heisler Sharp McKnight
The Changing Retirement Plan Market Landscape The proposed regulation arrives at a time when the retirement marketplace is facing the potential for sig - nificant change in retirement plan investments. As pri - vate market sponsors continue searching for access to defined contribution capital, there has been a rise in managed accounts, private equity, annuities and so-called “personalised” retirement solutions being pitched as alternative investment options for plan participants. The DOL’s proposal should not be read as a signal that fiduciaries should embrace such alternatives casually. Indeed, many fiduciary committees already struggle to maintain consistent monitoring procedures for tra - ditional fund line-ups on a plan. Sometimes, these committees attach too much importance to blindly going through the motions, repeatedly checking the same boxes. Many are under the illusion that being wedded to habit, rather than devotion to a prudent fiduciary process, satisfies their duty. However, under the DOL’s proposal, many fiduciaries evaluating more complex strategies will need enhanced governance structures, deeper investment expertise, outside con - sultants, revised investment policy statements, more sophisticated monitoring metrics, and substantially expanded documentation practices. The DOL’s proposal repeatedly emphasises analyti - cal rigour, comparison against similar alternatives, independent valuation methodologies, liquidity risk assessment and meaningful benchmark construc - tion. Analysing each proposed factor individually, and certainly taken together as a whole, the burden associated with satisfying the proposed safe harbour is considerably greater than some may appreciate. Assessing Performance “The fiduciary must appropriately consider a reason - able number of similar investment alternatives and determine that the risk-adjusted expected returns of the designated investment alternative, over an appro - priate time horizon and net of anticipated fees and expenses, furthers the purposes of the plan by ena - bling participants and beneficiaries to maximise risk- adjusted return on investment, net of those fees and expenses.”
The first factor requires fiduciaries to decide how much risk and volatility they want to expose their employees to. The lower the risk, the lower poten - tial for return; the higher the risk, the higher potential for return. Therefore, fiduciaries should evaluate an investment’s risk-adjusted performance net of fees as compared to a reasonable number of similar invest - ment alternatives. This emphasises the critical role that performance plays when evaluating plan invest - ment options. The purpose of a 401 (k) plan, after all, should be to grow investments into a retirement nest egg for employees while sparing them the stress of extreme up-and-down volatility. The key here will be diligent fiduciary rigour in evaluat - ing a number of undefined metrics. While the specific metrics will vary from plan-to-plan and investment-to- investment, a few in particular stand out. • First, creating objective metrics through which fidu - ciaries can determine which investment alterna - tives are “similar” to the one under consideration. • Second, determining which method of calculat - ing risk-adjusted returns applies best to the given investment type. • Third, determining the appropriate time horizons by which the fiduciaries will evaluate performance. The DOL currently requires plan fiduciaries to disclose investment returns for one-, five- and ten- year periods in annual participant disclosures. See 29 CFR Section 2550-404a-5 (d)(1)(ii)(A). Presum - ably, this would be a minimum expectation for the time horizons by which fiduciaries evaluate historic performance, though it may make sense to include additional performance periods depending on the investment type. Within each of these three illustrative examples there are myriad considerations that fiduciaries must con - sider. Fiduciaries therefore must establish and docu - ment their process and the rationale for why a select - ed investment’s expected risk-adjusted return profile is superior relative to available alternatives. Furthermore, the values of certain asset classes, such as commodities, options and cryptocurrencies, can change in the blink of an eye, and wipe out an entire portfolio without warning. Unless plan fiduci -
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