Investment Oversight: Look Beyond Scores!

Most retirement-plan consultants use just one type of review. They should add a second.

May 29, 2014

You know the drill. It’s time for the quarterly investment committee meeting on the retirement plan. Your consultant has used a “data-based” program to complete a review and handed you a report with colors and scores that indicate that the funds being offered to participants in the plan are doing well. Should you accept these scores and call it a day, or should you ask for additional information?

Most retirement plan consultants settle on one software program as the foundation for reviewing the investments offered in the 401(k) plan. But there are two main types of programs --analytics-based and data-based -- and a prudent fiduciary should use both. The analytics-based programs focus on assessing a manager's skill, behavior and asset construction. The data-based programs focus on measuring a manager’s results statistically. Analytics-Based Software: MPI, Zephyr Analytics

Produces a score for each investment.
Assesses a manager's skill, behavior and asset construction.
Evaluates the quality (in a quantitative way) of the manager.
Costs the consultant more but provides a more robust evaluation.

Data-Based Software: Morningstar

Produces a score for each investment.
Focuses on measuring manager performance and returns statistically.

If the score is similar in both programs, then the consensus would lead the fiduciary to a decision. If the scores diverge, then additional research would be needed before a decision is made about whether to retain the manager or hire a new one. Oftentimes, fiduciaries find it challenging to hold long-term performers through their inevitable lulls. Before any investment manager is hired or fired, fiduciaries should understand that most of the best managers will try everyone's patience with sub-par performance over three or five years. Understanding an investment manager's investment process, sub-styles and investment philosophies through varying market cycles will help fiduciaries make better decisions during performance lulls. This is extremely important to understand because approximately 90% of mutual funds that are top performers over 10 years in 17 categories spent at least one three-year stretch in the bottom half of their peer group. Although analytics-based programs go deeper in evaluating the quality (quantitative) of the manager as part of the overall score, they exclude critical components relating to the investment manager's investment process, sub-styles and investment philosophies. Providing deeper explanation of these critical components is something your plan consultant should provide as part of the fund-monitoring process. Consider asking your consultant to use an analytics-based software program in addition to what is currently being used, and to provide explanation on all the critical components to ensure the funds are meeting the highest possible standard for your participants.

Mark Ray

Mark is a retirement plan expert and registered fiduciary. Mark guides businesses through the challenges of managing a successful retirement plan by using analytical, teaching and interpersonal skills developed over more than 20 years in the industry.