Saturday, July 07, 2007

Other People's Money

I was on a panel at our recent Plan Designs conference, and the topic of qualified default investment alternatives (QDIAs) came up. There was discussion about the Department of Labor’s proposed regulations on the subject; some observations about when we might expect to see final regulations; and ruminations from co-panelists Fred Reish and Mike Barry about ERISA’s embrace of the concepts of modern portfolio theory (MPT), and the importance of capital accumulation rather than capital preservation in making “appropriate” investment choices for participants that hadn’t, for whatever reason, elected to make their own.

Then, a plan sponsor in the audience raised her hand and shared the experience of her plan—shared how they had carefully considered the alternatives of a stable-value investment alongside an asset-allocation alternative, and how they had decided on the former, and did so just before the market tanked in 2000. Her perspective was simply this: If they had chosen the asset-allocation alternative—chosen the option that many (most?) experts say they should have—people would have lost money.

These days, I think it is fair to say that “common wisdom” would call for a different decision. In fact, the expert panel went on to basically lay out all the reasons why that was, if not a bad decision, at least not the one that ERISA’s prudence standard would seem to call for.

Stable "Values"

I understand the logic and rationale behind that perspective; and frankly, IMHO, most of the admonitions to broaden the DoL’s proposed QDIA definition to include stable-value choices seem self-serving, at best. We all know the issues with stable value—it’s ill-diversified (at least from the standpoint of the participant investor, though I find that the “single asset class” labels are generally not precisely accurate), pricey, frequently layered with early withdrawal penalties and/or restrictions, and anything but “guaranteed” (the way the old GIC label suggested). Still, I suspect that, for most of the participants that choose the option (and plan sponsors who choose default investments for participants), stable value provides what they are looking for—a return of their principal investment along with some stated rate of income. Simplistically, a bird in the hand, rather than two in the bush.

That doesn’t mean that stable value will gain the Department of Labor’s (DoL) official endorsement as a QDIA, of course—and, if stable value fails to make that list, it certainly will diminish its allure as a default choice (little wonder that the stable-value industry is up in arms, and that the mutual fund industry, which stands to gain significantly by the apparent endorsement of target-date solutions, has weighed in on the other side). That point of contention notwithstanding, current trends certainly seem to favor the adoption of asset-allocation solutions, rather than stable value, as default investments. Let’s face it: There’s a definite allure to being able to match a defaulted investment choice with the retirement date of a participant—a one-for-all solution that nonetheless seems at least somewhat customized. Finally—and for the lawyers, no doubt, sufficiently—ERISA’s concepts of investment prudence may well presume a certain reliance on the principles of MPT, ultimately demanding an asset-allocation solution.

There remains, however, IMHO, a case for a potentially different result when it comes to making decisions about “other people’s money.” A solution that doesn’t require a plan sponsor to explain to participants about MPT, or to offer a rationalization about timing and the markets—and one that, certainly on a net basis, might provide a reasonable return compared with the relative volatility of an asset-allocation alternative. I’m not saying that that decision doesn’t have to pass ERISA’s muster, or that it doesn’t have, as outlined above, problems of its own. I am saying, however, that the plan sponsor is clearly responsible for the prudence of these default investments, and that they must therefore ask themselves, “Do I think that this default is prudent for the likely term of its investment in this plan?”

And if they can make a case for the prudence of that decision, then, “common wisdom” notwithstanding, I think they have a case.

- Nevin E. Adams

For some interesting perspectives on the inclusion of stable value as a QDIA, see “SURVEY SAYS: Should There Be a Stable Value QDIA?

See also “Default Ed

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