Plan sponsors must do their level best

The Fund Level
Governance at the fund level means measuring what the fund manager is going to do against what the manager said he or she was going to do, Iarocci said.

This is extremely important, particularly with prepackaged portfolio solutions — such as a target date fund (TDF) or a target risk fund. “The components of these solutions have to be pure in style and investment mandate,” said Iarocci. The solutions also have to align with member communications and be compliant with the Capital Accumulation Plan Guidelines.

According to one recent DC plan sponsor survey, 70% of respondents believe they will face legal challenges in the future. The main reasons for their concern are subpar investment performance, inadequate communication with members and inadequate retirement funds for members.

The plan sponsor needs to demonstrate that due diligence was done at the fund level and the portfolio optimization level, said Iarocci. “If you can demonstrate that, you should be okay.”

A good governance process at the fund level must have quantitative (i.e., aligning the source of added value with the source of risk) and qualitative (i.e., the investment team, its experience and philosophy) assessments. The process should also include a peer review to eliminate individual biases. “[Those] doing the governance should be making recommendations to an impartial committee,” he said. “And the committee should be looking after the interests of plan members.”

The Portfolio Level At the portfolio level, recordkeepers need to consider how to combine the funds and develop an investment policy that is aligned with a company’s plan members.

This is of particular importance when it comes to including alternatives in a portfolio, which is a growing trend with plan sponsors. But Iarocci said that’s easier said than done. “Incorporating alternative classes is a huge challenge,” he said. “There’s not a lot of history with private equity and infrastructure, [for example].”

Plan sponsors should consider many issues at this level, including the following:

• active versus passive management (Do you want to pay fees? Could the portfolio manager actually beat the index?);

• the number of managers (this will depend on the size of the plan);

• the glide path (What should it look like? For example, with a TDF, should it be more customized as the member approaches retirement?);

• manager diversification;

• different optimization methodologies;

• other definitions of risk; and

• a yearly strategic asset allocation instead of one every three years.

The Platform Level
The recordkeeper’s job is to provide a plan sponsor with all of the ingredients to provide well-diversified portfolio, said Iarocci. However, that doesn’t mean every ingredient.

“The trend over last 10 or 15 years with recordkeepers [has been] the more funds you have, the better your platform,” said Iarocci. “In fact, if you have them all, it’s perfect.” But Iarocci warns that this is not only a problem it’s also not good business. “It could drive up costs — and they could be paid by the plan members themselves.”

Iarocci couldn’t stress enough the need for governance at the fund, portfolio and platform levels and left his audience with this message. “Make sure that whatever we design for plan sponsors is well thought out and methodical. Let’s really do our homework at all levels.”