Friday, March 6, 2015

Plan Sponsors: Beware Reliance on Non-Fiduciary "Consultants"

I've previously written about the inability of a fiduciary plan sponsor to rely upon a non-fiduciary "retirement plan consultant." The thrust of my prior argument is that the fiduciary is bound to select experts diligently. Without the consultant possessing a fiduciary duty the plan sponsor is usually without a remedy should the recommendations later be shown to be poor, due to the shield of the low standard of suitability.

Permit me to expand upon that prior recommendation, by suggesting steps any plan sponsor or endowment fund should undertake to ensure adherence to its fiduciary duties.

Recent research indicates that these retirement plan "consultants" don't add any value. Yet, many pension funds and endowments hire investment consultants to help them choose fund managers. It is estimated that 82% of pension plans in the United States utilize such services. These consultants, often very large firms, charge hefty fees.

The 2015 Commonfund prize was recently granted to an academic paper that concludes: "we find no evidence that these (the consultants') recommendations add value, suggesting that the search for winners, encouraged and guided by investment consultants, is fruitless." Jenkinson, Tim and Jones, Howard and Martinez, Jose Vicente, Picking Winners? Investment Consultants' Recommendations of Fund Managers (September 26, 2014). Journal of Finance, Forthcoming. Available at SSRN:

The paper notes:  "The cost of pursuing a strategy of picking actively-managed funds, encouraged and guided by investment consultants, is considerable: the institutional funds in our sample charge, on average, 65 basis points a year, which is far in excess of the cost of alternative index-related strategies. Moreover, plan sponsors pursuing an active strategy tend to switch managers more often than those adopting an indexed approach, incurring transition costs which further widen the gap between the two approaches. Consultants face a conflict of interest, as arguably they have a vested interest in complexity. Proposing an active U.S. equity strategy, which involves more due diligence, complexity, monitoring, switching, and therefore more consultancy work, drives up consulting revenues in comparison to simple, cheap solutions."

So what should sponsors of either defined contribution plans or defined benefit plans do?

(1) First, the plan sponsor should get rid of all revenue-sharing payments. These create insidious conflicts of interest.

Third-party administrator (TPA)/recordkeeper and custodian fees should be negotiated separately from the fees of the investment adviser. A possible benchmark to utilize for TPA/recordkeeper fees might be Employee Fiduciary, LLC - a low-cost provider with an excellent reputation for service. Available custodial options must be considered depending upon the selection of the TPA/recordkeeper and, possibly, the selection of the investment adviser.

(2) Second, the plan sponsor hire a fiduciary consultant. A fixed fee should be negotiated for services in establishing an Investment Policy Statement for the plan (or endowment fund), which is essential, and for assistance in selecting investments. Ensure that the fiduciary consultant accepts no compensation from any other firm providing services or products to the plan or fund.

(3) Next, the plan sponsor should ascertain the process for selecting asset classes and then for selecting investment products in each asset class, given the needs of the plan, its participants, or the fund.

(4) Follow that process - with diligence and thoroughness. And use sound judgment at each step of the process. Insist that decisions be backed up by sound academic research, or back-testing of data (preferably over multiple data sets and time horizons), or both.

      (4-A) For the selection of asset classes to include in the plan, consideration should be given to the historical returns of those asset classes as well as correlations among them.

      (4-B) When the time comes for selection of specific mutual funds, the plan sponsor or endowment fund manager should insist that any review of investment product providers consider the "best" mutual fund providers. In my view, these are Dimensional Funds Advisors (, The Vanguard Group (, and TIAA-CREF ( Others might be added, but these three are strong candididates for the best mutual fund complexes.

Additionally, the plan sponsor or endowment fund manager might do well to insist that at least one-half of the mutual funds chosen are "passively managed" - i.e., not dependent upon either individual security selection by the qualitative judgment of active managers and not dependent upon market timing. While some of these passively managed funds might be index funds or index ETFs, to negate the transaction costs resulting from index reconstitution other "passively managed" vehicles might be utilized.

      (4-C) Insist upon a written report from the engaged investment adviser, containing the recommendations, along with all research and data which supports the recommendations.

(5) Undertake a comprehensive review, at least every other year. Periodic (quarterly) reviews of more limited scope might be undertaken.

It is time for "consultants" to be held to a higher standard - and to add value, for much more reasonable professional-level fees. No consultant should be hired who possesses a material conflict of interest.

Ron A. Rhoades, JD, CFP(r) is an investment advisor and attorney. Commencing in July 2015 he will join the Finance Department faculty at Western Kentucky University, where he will chair its rapidly growing Financial Planning Program. Ron may be reached at 

No comments:

Post a Comment

Please respect our readers by not posting commercial advertisements nor critical reviews of any particular firm or individual. Thank you.