R. Dean Piccirillo, financial advisor and principal with HBK Sorce Financial, LLC, is participating as a panelist for The Center for Due Diligence (CFDD) 2010 Advisor Conference held October 6-8, 2010 at the Fairmont Chicago-Millennium Park Hotel in Chicago, Illinois.

The CFDD’s 2010 Advisor Conference themed “New Age Marketing: What Worked In The Past Is No Longer Effective”, is an all business event designed to help retirement plan specialists adapt to new trends, increase activity and grow their business.  This year’s conference is expected to draw more than 1,000 retirement plan experts, including over 500 advisors.

Piccirillo is one of four panelists for the session entitled “The Intersection of Inbound Marketing, New Media and SALES” which will address social media strategy, blogging, compliance issues, and practical tools for managing online efforts.  Piccirillo is one of a handful of financial advisor bloggers embracing the use of social media for business.  He is a steering committee member and co-founder of the Social Media Club of Southwest Florida, and is a member of the Southwest Florida Regional Technology Partnership.  His blog deanpiccirillo.com was featured in the March 26, 2010 edition of The Internet & Marketing Report as an example of how the lines are blurring between blogs and traditional web sites. In his Content Marketing Today(.com) review article, Newt Barrett called Piccirillo’s blog, “simultaneously newsy and professional.”

Piccirillo is a Certified Financial Planner (CFP), Chartered Retirement Plans Specialist (CRPS), and Accredited Investment Fiduciary Analyst (AIFA).  He works closely with families helping them plan for their long-term financial objectives, manage their financial assets effectively and preserve their wealth for future generations.  He also leads HBK Sorce’s Retirement Plan Unit working with most of the firm’s corporate and institutional clients sponsoring qualified retirement plans.

Piccirillo is a member of The Financial Planning Association of Southwest Florida, local building industry associations, Cape Coral Chamber of Commerce, and is a Board member of The Greater Fort Myers Chamber of Commerce.

HBK Sorce Financial is an independent, personal financial planning and investment advisory firm with offices in Pennsylvania, Ohio and Florida.  Currently, the firm has over 3,000 personal, corporate and institutional clients with an aggregate total of over $1 billion in financial assets.  HBK Sorce Financial is affiliated with Hill Barth & King, LLC and its family of service firms and organizations.  Established in 1949, Hill, Barth & King is one of the nation’s largest accounting and business consulting firms with over 10,000 clients and all the resources of a large, multidisciplinary firm.

I recently had the opportunity to provide a review to a prospective qualified retirement plan client. The plan assets were between 3 and 5 million and the underlying investments were separate accounts of a group variable annuity product. A variable annuity separate account will typically either invest its assets into a retail mutual fund or retain an outside money manager as a sub-advisor to manage the account’s assets.

There are some professional advisors working in the retirement plan arena that have a rather strong bias against group variable annuity products when being used as funding vehicles for qualified retirement plans such as 401(k)s. I am not personally one of those who feel that they should never be used. I have seen situations where these solutions have been a good fit for the plan sponsor. With that being said, having investment options that are held within an annuity wrapper does not relieve plan sponsors of their responsibility to monitor the investment options that they are making available to their participants.

Additionally, because of how variable annuity products are packaged, it can be difficult to determine if there is a retail mutual fund being used as the underlying investment vehicle or if the insurance company sponsoring the product has retained an outside sub-advisor to manage the assets. In many cases there are recordkeeping and administrative fees that are also layered into the asset-based charges assessed against the plan. These asset based charges are removed prior to the calculation of the unit price of the separate account investment option, making it tough for most plan sponsors to determine the true cost to their participants.

Again, I want to emphasize that I am not inherently against group variable annuity products but do feel that they require an additional level of diligence from the plan sponsor, particularly as the size of the plan grows. I have observed many situations where a group variable annuity product was justifiable and reasonable for a small or startup 401(k) but over time, as the plan assets increased, was no longer the best solution.

During the recent product review I conducted for our prospective client, I was able to identify the underlying retail mutual fund within most of the group annuity separate accounts. For those retail mutual funds where I could identify the specific fund being used, I matched that fund with the least expensive share class for that same fund on an open architecture platform.

I went on to demonstrate that the plan sponsor could have obtained many of the same investment managers, funds, etc. by using a recordkeeping solution that allowed them to go directly to the fund managers outside of that group annuity shell. The savings available for each fund compared was between 0.05% and 0.55%. In most cases the savings on a per fund basis exceeded 0.25%. These small, incremental savings could add up to a meaningful amount over the course of the participants’ years of investing for their retirement.

Keep in mind, I was not attempting to show the client the best or most cost competitive solution in each asset class. I was simply attempting to demonstrate that the client could have obtained the very same investment option less expensively outside of the annuity wrapper. In many cases, further cost savings would have been available to the client when considering other no-load or institutionally priced investment options in the same asset class. Setting aside any considerations with respect to the fiduciary responsibility of a plan sponsor to make certain that the fees being assessed to their participants are reasonable, as a business person, if you can obtain the same service from the same provider 25 to 50% less expensively, why wouldn’t you?

In conclusion, group variable annuity products are not inherently bad choices as 401(k) investment options. However, the plan sponsor should appreciate that these are packaged products built by insurance companies and the underlying investment options are not considered retail mutual funds, but are annuity separate accounts. Consequently, the underlying fees associated with each separate account should be compared to the fees for the same retail investment option. I have seen cases where the separate account was priced less expensively than the publicly traded mutual fund, but this is not normally the case.

To stay up-to-date on prudent practices as a retirement plan sponsor, or to share this information please register for our newsletter by using the registration form located in the sidebar of this blog, or subscribe to our RSS feed. As always, we appreciate your comments, which can be added below. For compliance reasons, comments are monitored and reviewed as soon as possible before posting.

Disclosure:

Dean Piccirillo offers insurance products through HBK Sorce Insurance LLC. Investment advisory services are offered through HBK Sorce Advisory LLC. Mr. Piccirillo is not able to transact business in a state that he is not licensed or registered.

NOT FDIC INSURED. NOT BANK GUARANTEED. MAY LOSE VALUE, INCLUDING LOSS OF PRINCIPLE. NOT INSURED BY ANY STATE OR FEDERAL AGENCY.

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Common Fiduciary Challenges – Part 1

In my capacity as a professional advisor who consults regularly with plan sponsors, there are some common challenges with plan administration that I frequently encounter when a new client is referred to me. In this article, I will attempt to outline some of the most common deficiencies and what a plan sponsor can do to address them in the most effective manner.

Not having a prudent process to select and monitor investment options

Plan sponsors have a responsibility to ensure that their employees have a competitive mix of investment options to choose from in a defined contribution plan. In order to make certain that plan sponsors are able to meet this requirement in an efficient manner, it is useful to have a written process outlining how investment options will be chosen and monitored. An excellent tool with which plan sponsors can use to detail this prudent process is an Investments Policy Statement (IPS).

An Investments Policy Statement details how the plan will select and monitor the investment options that are available for participants to choose from. The IPS will typically detail the criteria with which these investment options will be reviewed. A typical selection criterion may include:

• Performance relative to a manager’s peer group over a certain period of time
• Performance relative to an appropriate index
• A fund’s expense ratio relative to it’s peer group
• Various methods of evaluating a funds risk adjusted returns such as Sharpe Ratio or Alpha
• The tenure of the manager or team of managers for the fund
• Style consistency – do the underlying holdings of the fund match the stated investment style of that portfolio?

There are many other criteria that are reasonable and could be used to evaluate a particular investment option. Some criteria that plan sponsors may want to consider included in their evaluation process can be found in another article on this blog – Selecting and Monitoring Mutual Funds. The key is to have a reasonable or prudent process and to follow that process.

Not following your stated process for evaluating investment options

Sometimes plan sponsors will have a reasonable, prudent process outlined for selecting and monitoring investment options. Many times, plan sponsors have even prepared detailed Investment Policy Statements when their retirement plan was established. However, if you’re going to have a written process for evaluating managers, it’s important that you follow the stated process and , are able to document that you’ve done so.

Plan fiduciaries must monitor their plans investment options on a regular and ongoing basis. This can be challenging for plan sponsors simply because of how busy the typical executive in a small or midsized company is. Regrettably, being busy does not eliminate the responsibility.

Not documenting that you have followed your stated process for evaluating money managers

As with many things in business, particularly from a regulatory standpoint, if it’s not written down it didn’t happen. As a plan sponsor, you may at some point be challenged about an investment decision that you made. If that time ever comes, being able to demonstrate in writing, that you have followed a prudent process may be critical.

Unfortunately many times, plans sponsors who have carefully monitored the performance of their plans investment options have no evidence that they have in fact done so. Retirement plan fiduciaries are therefore encouraged to maintain records confirming decisions that they made with respect to plan investment options. Records could include due diligence reports prepared for investment options in the plan or minutes from investment committee meetings.

The key is, being able to prove that you did what you said you were going to do from an investment monitoring standpoint? Are you able to prove that you followed your prudent process?

In part two of this series, we will continue to explore some common fiduciary challenges and how plan sponsors can most easily address them. A sample of an Investment Policy Statement, which we use in our practice, can be found at this link on our Resources page. We have also provided a link to a sample Due Diligence Report that has been designed to coordinate with our sample Investment Policy Statement.

To stay up-to-date on prudent practices as a retirement plan fiduciary, or to share this information please consider registering for our newsletter, you can find the newsletter registration form in the sidebar of this blog.  Another option to stay connected with our updates would be to subscribe to our RSS feed.  As always, we appreciate your comments which can be added below.  For compliance reasons, comments on this blog must be monitored however; we will approve and post your comments as soon as administratively possible.

Disclosure:

Dean Piccirillo offers insurance products through HBK Sorce Insurance LLC, investment advisory services are offered through HBK Sorce Advisory LLC and securities are offered through Purshe Kaplan Sterling Investments (PKS), Member FINRA/SIPC. PKS is headquartered at 18 Corporate Woods Blvd., Albany, NY 12211. HBK Sorce Insurance LLC and HBK Sorce Advisory LLC are not affiliated with Purshe Kaplan Sterling Investments. Mr. Piccirillo is not able to transact business in a state that he is not licensed or registered.

Have you ever been to an unfamiliar city and stopped for directions to get to your final destination?  If you were to ask several local citizens, you would likely receive multiple and even different detailed expressions of these directions.  The difficulty then becomes deciphering which “direction” will get us there quickly, and with a minimal number of “wrong” turns.  As investors your destinations are slightly different yet you commonly use similar investment vehicles (mutual funds) to travel this path.  Each of you plan and hope to reach your goals quickly and with minimal risk.

In fact, according to the Investment Company Institute, as of December 2007 there were over 8,000 mutual funds with approximately $9 trillion dollars of invested assets.  In addition, 51 million households (88 million individuals) owned on average $50,000 in mutual funds.  These statistics illustrate the popularity of mutual funds within the investment community, and in particular individual investors.  Thus, it is important that investors adopt appropriate evaluation criteria to navigate through this vast universe of mutual funds in order to decipher which are suitable for use within their investment portfolios.  For many investors, this is somewhat of a daunting task.

So as you travel on your financial path, how do you navigate through these investment vehicles to get to your final destination quickly and with the least amount of wrong turns?  Or, how do you best select a mutual fund managed by an ethical management team that performs consistently well when compared with other funds with the same objective and does so with minimal risk?  The answer is, this selection requires a considerable amount of effort and careful due diligence.  Such a task is not, however, an insurmountable one.

If investors prefer to work with a professional advisor who will recommend specific mutual funds to them, they may consider asking the advisor an important question: “Do you follow a similar selection and monitoring process when choosing which funds you’ll recommend?”  The Foundation for Fiduciary Studies in Sewickly, PA recommends that an investor or trustee examine the following eight specific aspects of fund performance and management when monitoring a manager:

1. Evaluate the fund’s performance relative to its peer group—a group of funds with comparable investment objectives

An investor evaluating a manager on a performance basis relative to that manager’s peer group should attempt to choose managers who consistently perform above the median or top half over a complete market cycle—typically considered to be at least three years.

2. Evaluate the risk that the manager is taking relative to the performance that the fund is providing to its shareholders

The Sharpe Ratio, a popular gauge in the investment community, is used to measure a fund’s risk-adjusted return.  Developed by Stanford University Professor William Sharpe, a 1990 winner of the Nobel Prize in Economic Sciences, the Sharpe Ratio is used to compare the relative performance of managers.  In general, the Sharpe Ratio tells us whether the returns of a portfolio come from smart investment decisions or from a result of excessive risk taking by the money manager.  Because it is a relative measure, there is no such thing as a good or bad Sharpe Ratio.  However, within a given peer group, the manager with the higher Sharpe Ratio is preferable.

3. Consider the product’s inception date

Generally, funds with at least a three-year performance history are preferable.  With fewer than a three-year performance history, it is difficult to develop meaningful comparative measures.

4. Correlate a mutual fund’s performance and stability to a peer group

For example, is the mutual fund’s style of investing consistent over time with the peer group characteristics?  When building portfolios, both investment advisors and individual investors will often make selections based on a model or target allocation.  In order to efficiently maintain that allocation, which some consider to be the most critical element in the investment management process—an investor must be confident that the mutual fund’s style will remain consistent.  Otherwise, they will be taking either more or less portfolio risk than they had originally intended.  For example, it would be important to know if a large, growth-oriented US stock fund were purchasing a disproportionate share of companies based in foreign countries.

In addition, a fund that is not highly correlated with its peer group renders the quantitative measures discussed above less meaningful.  Many of these measures of performance and riskiness are reliant upon appropriate and relevant comparisons.

5. Examine the fund’s total assets under management

Funds with total assets in excess of $75 million are considered preferable.  It is felt that at this level the manager will have the buying power and economies of scale to manage the fund cost effectively.

6. Determine if the underlying securities held by the portfolio are consistent with the stated investment style of the mutual fund

The objective here is to identify funds that have at least 80% of their assets in investments that match the stated investment style of the manager.  For instance, if a large growth US stock fund has 35% of its money in cash, an investor could be inadvertently over-weighted in cash and under-weighted in US stocks.

7. Determine the fund’s expense ratio or fee

All mutual funds have an expense ratio that’s charged against the fund’s assets under management.  This expense ratio is hidden from the investor and may be determined by examining the fund’s prospectus.  The fund’s expense ratio has significant impact on the fund’s performance over time.  For example, a fund with an expense ratio that is .75% (3/4 of one percentage point) higher than another comparable fund–all else being the same–will under perform by that amount each year.  When examining fund expense ratios, investors should look for funds with expense ratios that fall within at least the top 75% of their peer group.

8. Examine the stability of the organization

The first seven measures are very much quantitative benchmarks that are fairly easily measured for comparative purposes.  However, the qualitative benchmark of a mutual fund company’s stability is not as easily measured.  The mutual fund industry regulatory scandal from a few years ago is a prime example of why this qualitative measure is so important.  For example, some fund companies made deals with outside investors that allowed them to “time” their funds, thereby generating profits for themselves and diluting profits of long-term shareholders.

In some cases, fund companies allowed outside investors to place trades after the market closed in order to capitalize on news that would likely impact the next day’s prices of securities held in the fund. In the most egregious examples, in exchange for allowing these trading practices, the fund companies received compensation in the form of assets placed in other investment vehicles run by the fund company.  These violations of fiduciary responsibility on the part of such fund families can only be caught through a systematic process of surveying investment industry news, communications, and regulatory environment.  This is a difficult task for the individual investor.

In conclusion, the quantitative measures involve careful evaluation of a fund from a risk and return standpoint relative to its stated peer group.  The qualitative measure involves a vigilant, periodic review of the stability of the organization managing the mutual fund.  Investors not having the time, expertise or resources to carry out the systematic due diligence process may want to work with a professional advisor.  Investors who work with these advisors should then ensure that the professionals giving them advice are themselves following a comparable process of fund selection and monitoring.