How Much is Your Plan Adviser Worth?
“We give advice, but we cannot give the wisdom to profit by it.”
-Francois de La Rochefoucauld
With the recent trend toward fee transparency in small business retirement plans such as 401(k), plan sponsors are increasingly examining the fees charged by financial advisers and consultants. Although we have extensive data to quantify and benchmark advisory fees, a deeper understanding of the true value of these services is often needed by plan sponsors.
Historically, the process of quantifying this value has been highly subjective or simply not undertaken at all other than to identify the range of fees charged by other advisers for similar plans. Yet it should remain obvious to most prudent individuals that paying an adviser a fee greater than the value returned would not only be irrational but irresponsible.
While value and price considerations are central to making investment decisions in the financial markets, many plan sponsors have never taken the time to analyze the true value of a retirement plan investment adviser and his or her long-term impact on plan results. I liken this process to purchasing a security in the market by determining its value beforehand. Both price and value must be considered to make a successful investment. In a similar way, the fees that you pay your 401(k) adviser should have some relationship to the values received by both the plan sponsor and participants. The purpose of this article is to move you to take a deeper dive into the true value of institutional investment advice.
The Vanguard Study:
“Quantifying the Value of a Consultant”
As a 401(k) plan consultant and adviser specializing in small business retirement plans, I found a recent analysis published by Vanguard Research to be a highly credible effort to determine the value of services provided by institutional retirement plan advisers and consultants.
“Consultants can enhance and distinguish their value by placing even more emphasis on their fiduciary expertise, their experience with investment policy statements and other topics such as retirement plan design.”
“We believe that, when executing the Vanguard Institutional Advisors Alpha framework, consultants can add about 3.5% in value”.
If Vanguard’s calculations are accurate, a qualified adviser truly makes a significant quantitative as well as qualitative difference to a retirement plan and its participants. In isolation, however, it may be overly simplistic to apply this equation to every plan. Here’s a good way to explain why:
As the general manager of an NFL team, the value of adding a player such as Russell Wilson to your roster might be vastly different, depending on whether you are the New England Patriots or the Oakland Raiders. It would be logical to assume that Russell’s services today would likely be more highly prized by the struggling Oakland Raiders who are currently looking to rebuild their roster than by the Patriots who seem to find themselves in the Super Bowl on a fairly consistent basis.
Just as NFL teams have a diverse set of needs, so, too, with 401(k) plans. Do plan sponsors, for example, prefer higher absolute investment returns, or is reduced portfolio risk higher on their priorities? Are reducing plan costs and expenses high on the checklist, or is there a corporate mandate to increase the participation and deferral rates among participants? Finding an adviser who can guide, recommend and implement plan design features which achieve these overall plan goals may ultimately provide more value than one who focuses on directly reducing fees and expenses. In practice, both objectives are important, yet a consultant’s recommendations in regard to plan design may add significantly higher utility than simply attempting to reduce overall plan costs.
There appears to be little argument that the traditional approach to institutional adviser selection, retention or replacement has historically focused on investment performance. However, the Vanguard study concludes that a more accurate ratings system should focus on “non-investment issues within the adviser’s control” as well as higher investment returns. Importantly, the study attempts to quantify this value-add based on best practices in four advisory service areas:
- Fiduciary Considerations
- Investment Policy Statement
- Plan Design & Monitoring
- Investment Selection & Strategy
The conclusions of this study, with the term “alpha” representing additional advisor value, are summarized in the following table:
|Investment Policy Statement
|Plan Design & Monitoring
|About 350 bps (3.5%)
Source: Vanguard Research; “Quantifying the Value of a Consultant”, Michael A. DiJoseph, CFA; Sneha Kasuganti; Christopher Celusniak; Donald G. Bennyhoff, CFA; Francis M. Kinniry Jr., CFA. September, 2018
Tier 1: Fiduciary Considerations
As the Vanguard report observes, “effective consultants understand the complex landscape of fiduciary law and regulatory compliance and communicate this understanding to clients”. In addition, they act on this knowledge by applying best practices and conducting fiduciary training. But in truth, the best consultants will do much more. As an example, they are far more proactive in research on future trends and shifts in regulatory focus and litigation. Says Vanguard, “By helping clients to successfully navigate the regulatory backdrop and avoid lawsuits and enforcement actions they set their clients up for success”.
Although the consequences of compliance issues, class action lawsuits, and enforcement actions can potentially be financially devastating to all plan sponsors, this report’s assessment of the ultimate value of fiduciary guidance is very conservative. In fact, Vanguard quantifies this value as “something greater than 0 bps” to the average plan (a basis point is equal to one one hundredth of a percent). However, the reality is far too many small plans, particularly those currently represented by an agent of a broker dealer, or perhaps those lacking an assigned adviser altogether, are often dangerously unaware of even the most basic fiduciary practices. Although it is true that the proposed DOL Fiduciary rules mandating a higher standard of prudence and care for qualified retirement plan advisers was recently vacated by the US Court of Appeals for the 5th Circuit, plan sponsors should be reviewing their internal operations and their current and future providers in light of a higher future standard.
Added Value Through Fiduciary Considerations: > 0 bps
“In the business world, the rearview mirror is always clearer than the windshield.”
–Warren Buffet: CEO, Berkshire Hathaway, Inc.
Tier 2: Investment Policy Statement
As a second tier in regard to practices which are within the adviser’s control, the Vanguard analysis also places high client value on a well-crafted document called an Investment Policy Statement (IPS). The IPS essentially acts as a protective guard rail for the many decisions that must be made in regard to small business retirement plans such as 401(k). The authors point out that while commonly used ratings systems for business decisions are often based on past performance, these ratings systems can be risky when making investment decisions for a portfolio.
By helping clients create and adhere to an investment policy statement, a trusted adviser can add significant value and help prevent behaviors such as performance-chasing and market timing. Crucial elements of this document focus on portfolio objectives, asset allocation, risk management framework, manager search and selection, and committee governance.
Recent investment studies have found that clients and consultants alike can be swayed by historical performance. Among those cited by the authors is the 2014 Wimmer study sponsored by Vanguard and based on a sample of over 3500 mutual funds and over 40 million hypothetical outcomes to quantify the impact of chasing fund performance. Underperforming funds were sold and replaced with top performers using a three year evaluation window.  The results? Lost returns between 1.6 and 4.0% per year, not including transaction costs. The study concludes that a disciplined process of adhering to a well-crafted IPS as opposed to chasing performance can lead to significant long-term value.
Fiduciaries versus Experts
“An expert is somebody who is more than 50 miles from home, has no responsibility for implementing the advice he gives, and shows slides!”
-Edwin Meese, Former US Attorney General
One of the primary value-adds from an experienced investment adviser is that of a behavioral coach. As Vanguard states, “for a majority of plan sponsors, going against peers, consensus, intuition and human behavior is very difficult”. Most good advisers would probably describe their primary role as more of a “behavioral consultant” as opposed to an “investment expert”. Creating an investment policy statement that accurately reflects the goals and objectives of the plan sponsor effectively imposes even more safe guards around policies which truly benefit participants. Acting as a fiduciary as opposed to simply making recommendations as an expert carries with it the added responsibility to ensure that these policies are implemented.
-Added Value Through Adhering to Investment Policy Statement: 1.5%
Tier 3: Plan Design and Monitoring
A third tier of non-investment services within the control of an institutional adviser involves constructing an appropriate investment lineup, implementing intelligent plan design options (choice architecture) and regularly conducting informed monitoring of plan effectiveness.
Constructing an Investment Lineup
An experienced plan adviser would be expected to adhere to four important criteria in constructing a plan investment lineup:
- Identify plan objectives.
- Focus on the fundamentals of investing.
- Create and maintain a tiered lineup that reflects plan objectives.
- Provide active and ongoing oversight
In many cases with small business 401(k) plans, decisions with regard to plan investments are simply predetermined, one-size-fits-all choices made by the plan recordkeeper. Many of these investment lineups contain self-serving conflicts of interest, higher fees and lower performance. We discussed these issues in an earlier blog, “Is Your 401(k) Plan a Product or a Service?”On the other hand, an experienced adviser acting in the best interests of the participants can be a significant asset in this important process. The result are more appropriate investment choices, lower fees and better performance.
Plan Design Considerations
In the area of plan design, recent surveys reveal significantly higher participation rates for plans with auto-enroll and auto-escalation features. Despite these dramatic results, baseline plan experience for 401(k) plans remain one in which plan participants must individually make active decisions to save at all, to save more and to invest wisely. Vanguard estimates that the addition of an automatic enrollment plan design feature increases the plan participation rate as well as adding approximately 1.4% annually to the wealth of the average employee over 30 years. Further, including an automatic escalation feature increases this additional return by 20 bps, or to 1.6% annually over the same period. Finally, Vanguard’s study reveals that utilizing a proper QDIA or default investment choice would increase this additional return to 2.00%, primarily due to minimizing the negative effects of market timing and performance chasing.
How is it working?
An adviser who includes the service of monitoring plan effectiveness through capturing and analyzing metrics such as participation rates, savings rates and investment decisions can identify specific areas of employee communication and education that could be the key to ensuring that this 2% in added value is actually compounded over time.
-Added Value Through Plan Design and Monitoring: 2%
Tier 4: Investment Strategy
Because 401(k) investment decisions are made by the participants, the Vanguard study deems this expertise not applicable to advisers representing defined contribution plans. However, advisers who differentiate their services based on participant education and communications can add tremendous value to participants in positively influencing their individual investment strategies and as a result, their long term results.
The-Added Value Through Investment Strategy: N/A
Wrapping it Up
While it is vitally important to understand that the true added value of your adviser should be based on the individual objectives of your plan, there is no doubt that retaining the services of a qualified plan advisor adds significant quantitative and qualitative value to most 401(k) plans. With financial markets increasingly unsettled and volatile, participants are asking fundamental questions regarding the risk characteristics, investment performance and fees associated with their investment choices.
Based on my experience, most plan sponsors would gladly defer those conversations to a highly qualified investment adviser. As the Vanguard study reveals, they would be wise to do so!
Brian C. Rall
President, Strategic Retirement Partners, LLC
Strategic Retirement Partners is an independent, boutique investment advisory and consulting firm providing plan design, vendor search, investment selection, fiduciary guidance and participant education for company sponsored retirement plans.
Strategic Retirement Partners, LLC is a registered investment advisor in the State of Washington. The investment advisor may not transact business in states where it is not appropriately registered, excluded or exempted from registration. Any information contained herein or on SRP’s website is provided for educational purposes only and is not intended to make an offer or solicitation for the sale of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated are not guaranteed. SRP does not provide legal or tax advice and clients should consult their attorneys and CPA for any strategy discussed herein or on this website.
Michael A. DiJoseph, CFA; Sneha Kasuganti; Christopher Celusniak; Donald G. Bennyhoff, CFA; Francis M. Kinniry Jr., CFA. Vanguard Research, September 2018.
Wimmer, Brian R., Daniel W. Wallick, and David C. Pakula, 2014. Quantifying the Impact of Chasing Fund Performance.Valley Forge, PA.: The Vanguard Group.
Brian C. Rall, President, Strategic Retirement Partners, LLC. August, 2018