• Participant investment management services. A managed account service is just that…a service. It is not a product. As a result, the focus of the fiduciary process should be on the service provider. For example, information should be gathered and evaluated about the qualifications and experience of the advisory firm, the quality of the services and the reasonableness of the fees. That information should be evaluated in light of the objectives of the plan to provide long-term strategies for retirement benefits.

Investment management services can be used to benefit participants for both investing their plan accounts to grow their retirement savings and to help with the even more complex investing strategies for withdrawing benefits in retirement. Some managed accounts are now using allocations to guaranteed income products to provide for an insured income stream in retirement.

• Investment management services are an important and distinct service for a plan. While some plan sponsors may see the recordkeeper as a bundle of products and services that should be viewed as a single, unified proposition, care should be taken in selecting participant investment managers on that basis. A participant investment manager can significantly affect the retirement outcomes for participants. A better approach is to engage in a separate process for selecting those managers—through, e.g., an investigation of the available services or a Request for Proposal (RFP) process.

• Participant investment management and DOL guidance. The Department of Labor (DOL) has recognized participant investment management as a service that can be used by participants. Some of the guidance includes: the QDIA regulation, Interpretive Bulletin 96-1, Field Assistance Bulletin (FAB) 2007-01, and participant disclosures under the 404a-5 regulation (and the associated Frequently Asked Questions (FAQs) in Field Assistance Bulletin (FAB) 2012-02R). Those FAQs introduced the concept of DIMs, Designated Investment Managers, and described the disclosures that plan sponsors should make to their participants about the DIMs. The QDIA regulation named managed accounts as one of the three options that could be used for the fiduciary “safe harbor” qualified default investment alternatives for participants who did not direct the investment of their accounts. The Interpretive Bulletin explained that the selection of participant investment advisers was a fiduciary act and implicated the prudent man rule. And, finally, the 2007 FAB informed plan sponsors about their fiduciary responsibilities and processes for prudently selecting and monitoring participant investment managers.
  

ERISA’s fiduciary rules say that the selection of plan service providers is a fiduciary act.

• The fiduciary process for selecting and monitoring participant investment managers. ERISA’s fiduciary rules say that the selection of plan service providers is a fiduciary act. Interpretative Bulletin 96-1 explained: 

“As with any designation of a service provider to a plan, the designation of a person(s) to provide… investment advice to plan participants and beneficiaries is an exercise of discretionary authority or control with respect to management of the plan; therefore, persons making the designation must act prudently and solely in the interest of the plan participants and beneficiaries, both in making the designation(s) and in continuing such designation(s).”

In FAB 2007-01, the DOL went into more detail about the selection and monitoring process: 

“With regard to the prudent selection of service providers generally, the Department has indicated that a fiduciary should engage in an objective process that is designed to elicit information necessary to assess the provider’s qualifications, quality of services offered and reasonableness of fees charged for the service. The process also must avoid self dealing, conflicts of interest or other improper influence. In applying these standards to the selection of investment advisers for plan participants, we anticipate that the process utilized by the responsible fiduciary will take into account the experience and qualifications of the investment adviser, including the adviser’s registration in accordance with applicable federal and/or state securities law, the willingness of the adviser to assume fiduciary status and responsibility under ERISA with respect to the advice provided to participants, and the extent to which advice to be furnished to participants and beneficiaries will be based upon generally accepted investment theories.”

In other words, in order to engage in a prudent process, the fiduciaries must obtain information about the quoted criteria and assess that information in order to reach an informed and reasoned decision about whether to offer that investment manager to the participants. Then the fiduciaries must periodically review the investment manager applying similar criteria.

While investments are commonly evaluated based on performance compared to benchmarks, that’s not the case with investment management services. Investment funds, even complex funds such as target date funds (TDFs), are generic in the sense that funds fall into defined categories. For example, all 2040 funds share a single, common target—retirement in 2040. Even though some TDFs may be managed more conservatively or aggressively than others, they share a common objective and are, within reason, comparable. When managed accounts are truly personalized based on multiple data points, the funds of two participants, even of the same age, may have very different objectives. For example, one 50-year-old may be well-funded for retirement and therefor may have a desire to avoid the possibility of large losses, while another may be behind schedule in retirement savings and therefor may be willing to run the risk of greater volatility in order to grow his or her retirement account. Those two portfolios can’t realistically be benchmarked against each other. That’s why the DOL’s guidance on monitoring focuses on the investment manager and the manager’s experience and qualifications. And that’s what is required by ERISA.

If a plan sponsor nonetheless wants to look at performance, one approach would be to identify the participants with conservative investment profiles and those with aggressive investment profiles and review the investment of their accounts to determine if their allocations are consistent with the profiles. However, that’s not required.

The requirement that the advice be based on generally accepted investment theories deserves comment. While generally accepted investment theories are not defined in the FAB, it is commonly accepted that modern portfolio theory (MPT) is a such a theory. As a result, the plan fiduciaries should determine if the investment adviser will be constructing portfolios based on MPT, including asset allocation, periodic rebalancing, risk tolerance of the participant, and other participant objectives and concerns that are relevant to investing for retirement for a particular participant.

With regards to qualified default investment alternatives (QDIAs), plans may decide to default participants into target date funds, balanced funds, or managed accounts. The decision of which type to pick as a QDIA is not a fiduciary decision. That is, plan sponsors may select the particular type of investment product or service without concern about possible fiduciary liability. However, once the decision is made about which of those 3 types of QDIAs is made, the selection of a particular product or service is a fiduciary decision. This discussion in this article about the considerations for selecting a managed account service also apply for that purpose.

Plan fiduciaries should consider the ‘individualization’ of the managed accounts and the additional services that are offered.

• Cost of the investment management services. ERISA requires that the cost of plan services, including participant management services, be no more than a reasonable amount. But “reasonable” cannot be determined in isolation. The reasonableness of any expense must be determined in relation to the service provided. For example, if an investment management service simply replicated the asset allocations of a plan’s TDFs, a plaintiff’s attorney might argue that any additional expense for the management service was excessive (and that argument has been made in at least one case). As a result, plan fiduciaries should consider the “individualization” of the managed accounts and the additional services that are offered. On the first point—individualization—the issue is whether the asset allocations among the plan’s funds is designed to take into account the particular circumstances and needs of a participant. Obviously, TDFs don’t, and can’t, do that; they only take into account a participant’s age. In order for a managed account service to be truly individualized, the investment manager must have information about the participant. In some cases, investment advisers are able to obtain multiple data points about a participant from the plan’s recordkeeper. Those data points can include age, gender, account balance, compensation, and so on. If the adviser is equipped with a robust set of data points (from, e.g., the recordkeeper and the participant), the investment management can be implemented to specifically meet the needs and circumstances of the participant. In addition, some investment management services offer additional features, for example, projections of retirement income, recommendations about contributions to the plan, and so on. The combination of augmented services and individualized investment management can be assessed in determining the reasonableness of the cost for the services. 

• Additional considerations for the cost of investment management. While individualization of the investment management can support the reasonableness of the fees, plan sponsors, as fiduciaries, should first consider whether the service would provide additional value to the participants. Stated differently, would it help at least some of the participants to have professional management of their accounts? Would it help the participants in reaching their retirement goals? The general approach of ERISA’s fiduciary rules is that plans can incur expenses if they support the intended outcomes of the plan. To take that a step further, plan fiduciaries can pay higher fees for higher value. The rule is not that the cheapest services and products be used by a plan. Instead, it is that fiduciaries must evaluate costs in light of the services provided and the value of those services to the plan. 
  

The higher value that justifies the investment management fees can come from the investment services and from additional services that can be provided to participants. For example, other services could include: advice on whether a participant needs to save more for a secure retirement; consideration of non-plan assets in both investment and savings advice; and adjusting the retirement age assumptions based on a participant’s objectives.