How much alpha can advisors really add? How do you truly rate and benchmark a 401k plan’s performance against peers?
Al Otto thinks he’s figured it out, and it involves analytics (of course). After successful RIA and retirement plan careers, Otto and partner Mark McCoy noticed dangerous misconceptions about 401ks taking hold with employers—and plan advisors.
In particular, they saw that price dominated skill in plan evaluations, so they developed a list of questions about what should also be included in the mix. It led to algorithms that readily measure the value added to a plan from investment decisions over time.
The result was Veriphy Analytics, a firm that provides “objective insight into the health of your retirement plan.”
Otto sat with 401(k) Specialist for a wide-ranging interview about advisor accountability in the performance of the plan, and how it can be accurately measured.
More about Veriphy can be found at www.veriphyanalytics.com.
Q: You mentioned the falsehoods you saw floating around the industry involving retirement plans. What are they?
A: I’ll give you four specific ones.
- “Low fees produce better outcomes.” While it’s possible, it’s not always true.
- “Passive funds always outperform active funds.” That is unequivocally not true, depending on the asset class.
- “Target date funds produce better outcomes.” Well, that’s not always true.
- Recently, I’ve seen information that is actually quite concerning to me, and that is that investments in 401k plans are all the same. Our data make it very clear that that’s not true.
But, what happens is in this industry approaching $8 trillion in assets, is that investment and advisor decisions are being made on inputs and assumptions. The biggest input is, “What is your fee?”
There’s no question that fees are very measurable and important, as they need to be reasonable. However, in general, while there are all kinds of measurements around investment managers, I believe we’re the first company in the country to measure investment advisors or decisions at the committee level. So, we’re measuring a plan’s investment outcomes, and there are large disparities among plans. It’s fun to see this evolve.
Q: How do algorithms and methodologies like yours work?
A: We begin with common sense. So, if you’re going to measure a 401k plan against a 403(b) plan, you’ve got to have a way to normalize them. Common sense will tell you if you have more return and less risk than a given benchmark, that’s good. And if you have more risk and less return than the benchmark, that’s not so good.
We actually started with that, so our output could be seen by the benefits manager and easily understood. Yet, we have drill-downs, so that the chief financial officer, who might be the investment person on the committee, can really dig down fairly deep to get information. We have a patent pending methodology, it’s called Veriphy Ratio, that’s similar to a FICO score, in essence, for a retirement plan.
Q: How is it presented to the client or committee? Is it intuitive?
A: If it’s positive, then value has been added on a risk-adjusted basis. We give credence to people taking less risk that adds value. People don’t necessarily think about this, but participants leave 401k plans all the time. Quite often, if they time their leave and the market goes down a little bit, they want out—immediately.
From a plan management perspective, you want to minimize the volatility in the plan as much as possible while still taking advantage of the tide moving up in the marketplace. We give a positive weight to lower risk than the benchmark, and we look at all of the asset classes in a plan.
We set a benchmark so that there are, I believe, up to 189 asset classes. We have that many because we want to be [as specific] as possible when we’re evaluating whether value’s been added. You can’t just say, “How did you do versus the S&P?”
Q: You’re talking about holding retirement advisors accountable. What’s the response been so far? Are they happy with something like this, or weary?
A: One of the first advisors we spoke to was Matt Gnabasik of Blue Prairie Group. He’s a thought leader, and they’re a whole team of thought-leaders. Matt just stopped us and said, “Wait, I get it and thank you. Finally, somebody is going to be able to show the value that we are bringing to the table.”
We have advisor groups that are, I would say, elite subscribers. They’re happy because we’re able to demonstrate the value they’ve added. One of the things that we measure is the actual excess return delivered from the investments over time, and the risk that was taken to deliver it. We have plans where literally, over the last seven years, the plan has had over 20 percent absolute excess return above the benchmark with slightly less risk than the benchmark. That is phenomenal. And we have seen the exact opposite, where as much as 20 percent less return than the benchmark with more risk, and that’s awful.
Q: So, if you’re doing it right, you’re going to love it. If you’re doing it wrong, you’re going to hate it. It’s not really rocket science, right?
A: I think the other thing that’s really important is it is not our intention to make this information public. We’ll make general information public as we gather it, but we’re not going to post the lowest scores, because those firms must be able to utilize the data to improve themselves.
Our intent in the long-term is to build a community of, generally fiduciaries—the plan committee members and service providers—that are excellent and want to continue to improve and excel.
Q: Participant outcomes is a current buzzword. Does this help with outcomes, and if so, how?
A: We only measure things that are factual, and we want to measure actual outcomes. So yes, we do participate in that, and we agree that retirement dignity, retirement readiness is incredibly important. So, we can measure, rather than “What’s the increase in my deferral rate?” the question becomes okay, “What is the ongoing increase in my contributions and my average account value, and how does that compare to others in my industry?” I say “in my industry” because you can’t compare an airline to Joe’s Welding Shop. But we have the data.
Q: So, are you taking advantage of big data then, in terms of the recommendations that you’ve made?
A: We are. There’s a component of our data engineering that uses artificial intelligence. We gather our data from Form 5500, unless it’s a client and then we get the information directly from the custodian.
Our broad analytics use annual Form 5500 filings. Anybody that’s worked with Form 5500 will tell you that trying to get a hold of that information is a dirty job. It takes a fair amount of domain expertise to understand how to pull that information out, especially when you have complex plan structures.
I think we’ve made some really wonderful headway in that regard. Still working on getting everything in the database, but we’ve got a large majority of the plans that actually file an audit with a statement of accounts.
Q: Is this the first of its type? Do you have many competitors?
A: So, I don’t know of anybody that’s doing this yet. Most of the analytics that are out there are really focused on fund measurements, and we’re very focused solely on plan measurements.
It’s our hope that this truly improves outcomes throughout the industry. It’s our hope to increase the profitability of advisors that are good, and the recordkeepers and fund management firms that serve with them. I think that just bringing more transparency to the table will lift the level of competency in the industry, and that’s what we’re trying to do.