Separately managed accounts are good for high-net-worth clients, so why not 401(k) participants? New technology is now available to make it happen.
Many investment advisors use separately managed accounts in their high-net-worth client portfolios. It’s easy to see why; they offer a low-cost, transparent way to deliver investment management services that are customized to individual needs. However, advances in technology have also made it easy to offer SMAs in 401(k)s as well, even for the smaller plans. So how can advisors implement these strategies for retirement plan clients?
First, some context. SMAs are typically based on one or more investment models that vary in their risk and return characteristics. This allows plan participants to choose a single option that aligns with their unique investor profile, instead of having to make individual selections and manage their own portfolios. Because most 401(k) participants lack the knowledge to create a properly diversified portfolio, offering SMAs that consist of a series of risk or age-based investment models simplifies the process.
Until recently, technology for offering separately managed accounts in 401(k) plans, especially smaller-size, was inefficient (to say the least). Money managers either had to work directly with record keepers to implement individualized trading and recordkeeping processes or construct other investment vehicles that trade in a similar manner to mutual funds. While they may have been cost-effective for very large 401(k) plans, these approaches were often expensive, impractical or simply not scalable for smaller plans.
One popular approach, constructing investment models on the record keeper’s platform using the mutual fund options available in the plan’s core lineup, has problems. For instance, any changes to the models are more visible to participants, which creates confusion and requires increased communication to participants, which drive up costs and complexity. When a fund no longer meets the objectives of the plan’s investment policy statement, it needs to be replaced. The plan is therefore required to provide investment change notices, which is a significant administration burden for the advisor, record keeper and plan sponsor.
Another challenge relates to compliance and fee disclosure rules. A model portfolio that includes funds not offered to participants as an individual investment in the core lineup is considered a “designated investment alternative” (DIA) under fee disclosure rules. The advisor and record keepers are required to provide certain DIA disclosures, including historical returns, expense information, benchmarks, and a special website where participants can access detailed information about the investment.
Most recordkeeping platforms and advisors are unable to keep pace. Further, when DIA models are built on a recordkeeping platform using a core lineup, an advisor often feels constrained in their abilities to create suitable portfolios. They want access to a range of mutual funds and exchange traded fund options, rather than those limited to the core offering.
For retirement plan advisors experiencing these issues, take heart. Today, several 401(k) custodians have developed technology to seamlessly allow advisors, asset managers, and record keepers to offer SMA-like portfolios to their clients in a scalable, cost-effective manner. While seemingly new, these advances are actually iterations of systems that have been used for many years. In other words, they’re time-tested and trustworthy.
Managers can utilize the custodian’s proprietary technology to rebalance assets, replace or add investments, apply and collect management fees, manage fee disclosure requirements and interface with the plan’s record keeper. Each model portfolio is assigned an individual “ticker” by the custodian, allowing the record keeper to trade the portfolio in the same manner as a mutual fund. All changes the manager makes to a portfolio are applied across all 401(k) plans, but includes an “override” option at each plan, one that can be applied with minimal effort. These new systems also allow advisors and record keepers to comply with the aforementioned fee disclosure rules for DIAs.
In 2010, Mid Atlantic Trust Company released ModelxChange. It allows advisors two options—manage the plan themselves or outsource to third-party money managers. Both options include a seamless interface to the plan’s record keeper. Plan participants can access the investment model as they would a mutual fund in the plan’s core lineup. Advisors are now using ModelxChange to create model portfolios for both their 401(k) clients and individual investors, providing greater efficiencies.
“Approximately 18 percent to 20 percent of all new fee-based plans being on-boarded with Mid Atlantic Trust are taking advantage of ModelxChange,” explains Tim Friday, president of Mid Atlantic Trust Company. “We attribute this increase to several factors, including advisors seeking lower-cost investment solutions for their 401(k) clients, the need for increased transparency over traditional options, and the ability to improve operational scale and efficiency.”
In 2014, Matrix Trust Company released the Matrix ModelTool(k)it in partnership with Envestnet. Like ModelxChange, it allows advisors to construct and manage separately managed accounts for their retirement plans with access to over 17,000 mutual funds and ETFs. Advisors also have access to Envestnet’s staff of CFAs and PhDs to vet models, managers, and provide fiduciary support.
In 2015, Pershing launched the Pershing Retirement Plan Network (RPN), which provides 401(k) custodial solutions to their broker-dealer and RIA clients. With the launch of RPN, Pershing included a model management tool as part of their core services via their Retirement Model Manager technology. Like ModelxChange and ModelTool(k)it, Pershing’s RetirementModel Manager solution gives advisors the ability to build and manage custom model portfolios.
Prices vary; Mid Atlantic Trust charges 3.5 basis points for use of the ModelxChange. The charge, along with the advisor’s fee, can actually be accrued and calculated into the model’s unitization fee on a daily basis.
Advisors who wish to offer separately managed accounts from third party professional money managers have a wide variety of options from which to choose. They include a range of investment approaches and styles, including both ETF and mutual fund-based portfolios (or a combination thereof), tactically managed risk-based and age-based portfolios, and fully-invested portfolios. There are generally no minimum investment requirements, so they scale to both small and large retirement plans, and many are also available as the plan’s qualified default investment alternative (QDIA).
One example is 7th Harvest Investments. It offers three risk-based portfolios, including Conservative Harvest Builder Strategy, Moderate Harvest Builder Strategy, and Growth Harvest Builder Strategy. Each portfolio has a different risk-return profile built with ETFs. 7th Harvest follows a highly disciplined investment process based on four principles: transparency, efficiency, liquidity, and objectivity.
Another portfolio manager available on both ModelxChange system and Matrix’s ModelTool(k)it is 3D Asset Managers. 3D Asset Managers offers both risk-based portfolios and a unique approach to managing target date portfolios and, has partnered with Newfound Research to offer the 3D/Newfound PrudentPath Target Date Portfolio Series.
The strategic component of the PrudentPath portfolios maximizes equity exposure in positive market conditions, while the tactical component alters equity exposure during down market conditions. The composition of the defensive sleeve is based on where each portfolio lies along the glide path. Like most target date investments, the glide path becomes more conservative over time, but unlike most target date investments, the glide path has flexibility to increase or decrease equity exposure along the way.
“While we offer and believe in the risk based approach when an advisor has the ability to sit down with a participant one-on-one and walk them through a risk profile process, this does not happen with each and every participant in many employee plans,” explains Steve McCoy, CEO at 3D Asset Management. “As a result, we wanted to offer a similar customized solution that exists in large plans for participant in smaller plans, who are ultimately defaulted into the QDIA, or who do not have their risk profile reassessed after their enrollment.”
Advisors who wish to differentiate themselves by offering model-based, separately managed accounts to their 401(k) plan clients can now do so efficiently and cost-effectively, even for the smallest of 401(k) plans. These solutions bring a tailored, lower-cost approach to offering professionally managed accounts to plan participants than ever before.
John M. Humphrey is chief operating officer with July Business Services.