From an advisor perspective, there are obvious advantages to focusing your practice on working with Defined Contribution (DC) plans. One fundamental characteristic of the DC industry is that you almost always work with fewer, but larger clients than a traditional advisor… Article Presented By: Franklin Templeton
From an advisor perspective, there are obvious advantages to focusing your practice on working with Defined Contribution (DC) plans. One fundamental characteristic of the DC industry is that you almost always work with fewer, but larger clients than a traditional advisor who focuses on individual wealth management.
While your client base may be relatively stable, this relative concentration also comes with an obvious downside; fewer overall clients means less diversification of your revenue stream versus mass-market financial advisors. It also means that competitor advisors have good reason to target your valuable client base. Moreover, rapidly advancing technology that collects and organizes data from public Form 5500 filings and 404(a)(5) disclosures puts the details of plans you advise on full display to your competition.
The good news is that Collective Investment Trusts (CITs) can be part of a strategy to build—and defend—your business while also potentially reducing litigation risk, all while improving your value dynamic.
CITs can help with current client retention
For the most part, it’s much more efficient to retain the DC plan clients that you already have than invest in building new client relationships. CITs can help you shore up your existing client relationships and head off predatory competitors, sometimes well before an off-cycle RFP is issued.
While your services are technically distinct from recordkeeping and asset management, your clients probably see you as part of an integrated package: advisor services, plan administration, and investments. Predatory advisors can easily challenge you on one, two, or all three of these fronts in any attempt to unseat you as the plan’s advisor.
Competitor advisors can easily score points with unwitting DC plan clients by proposing a potentially less suitable set of investments at a reduced overall expense. Whether that means an over-reliance on passive investment strategies or an alternative series of target date funds, precise reporting of investment management fees in dollar terms—especially in this era of widespread 408(b)(2) disclosures—can facilitate unfavorable (and possibly misleading) comparisons between current and proposed investment menus without regard to more nuanced assessments of investment suitability. As we all know, cheaper does not necessarily translate to better value.
Given that competitor advisors who aim to use plan expenses as a lead-in to taking over a client will almost certainly propose a less expensive (and potentially less suitable) investment menu, anything you can do to reduce investment management costs in advance is a solid defensive move.
CITs can facilitate new client acquisition
You may dream of having warm-lead referrals actively seeking out your services, but more realistically, acquiring new clients can often be an expensive and time-intensive process during which you need to define and assert the value that you can bring to the client. Once established, you’ll also have to explain how your approach is superior to the second, third, fourth, or fifth advisor bidding on the same business (in other words, differentiate).
Recommending a CIT in place of a comparable mutual fund may lower overall investment expenses, and that may be a welcome edge. However, beyond simple cost savings, actively bidding for a new plan is also an opportunity to think constructively and dynamically about a prospect plan’s investment menu.
Menu simplification: CITs provide a means by which to strategically simplify a plan’s investment menu and help improve participant engagement, without sacrificing diversification potential.
New asset classes: Perhaps there is a sub-asset class that may offer diversification benefits within a broader allocation but that you would be reluctant to recommend as a standalone investment option.
Open architecture: Alternatively, you might question the ability of a single firm to manage a diverse array of asset classes needed in a target date fund, and look for an open architecture solution, perhaps blending passive with multiple active investment management sub-advisors.
Whether as fully custom “white label” or pre-packaged investment options, anything that demonstrates your skill as an investment advisor can help distinguish you from your competition.
CITs may help strengthen ERISA compliance
The Employee Retirement Income Security Act of 1974 (ERISA) specifies a fiduciary standard, or “prudent man standard,” requires any person who exercises discretion in the management and administration of the plan or in the investment of the plan assets must do so in the interest of the employee plan participants and beneficiaries, in accordance with the plan documents, and invest assets in a diversified manner. As part of that responsibility, investment expenses must be considered reasonable and therefore the plan fiduciary should benchmark the costs of products against similar products with similar benefits and features.
However, that does not mean investment expenses should be the only consideration. In fact, one probable reason for the expanding use of low-cost passive investment strategies is the belief that by using the least expensive investment solutions, you can secure greater compliance with ERISA fiduciary standards and reduce participant litigation risk. However, there is a potential snag in this race to the bottom.
For instance, is a 0.06% index fund management fee “reasonable” when a different fund tracking the same index charges 0.04%? Moreover, how does this drive to ever-lower investment expenses track to your fees as a plan advisor?
There is no requirement under ERISA that plan fiduciaries must choose the cheapest option available. However, CITs may allow you to assert that you are providing prudent investments in the most efficient, cost-effective vehicle available for a given investment strategy. In other words, you are providing value beyond what lowest-cost solutions can offer.
To learn more about CITs, visit our webpage.
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