Monday, April 7, 2014

Would You Let Plan Participants Invest in Hedge Funds?

by Jeff Briskin
President, Briskin Consulting

If you're like most advisors or plan sponsors, your answer to that question is (hopefully) "Certainly not."

Yet, I recently received an email from the Center for Due Diligence (CFDD) promoting a new microsite they've created to serve as an "educational" clearinghouse for information on "liquid alternative funds available for DC plans." View it here. 

Now, I have a lot of respect for the CFDD. They're a great resource for information on issues of interest to plan sponsors and advisors. I've even served as a panelist at their advisor conference. But, for the life of me, I can't figure out how posting a list of 40 Act alternative funds serves the best interests of anyone other than the fund companies that created them.

The CFDD's list is divided into two categories: fund families and fund categories.These categories run the gamut from "bear market" to "managed futures" to "multicurrency" to "long short equity."

DC Plan investment selection processes must comply with ERISA's fiduciary guidelines, which require that: 
  • Funds evaluation and selection reflect a prudent investment process that carefully weighs risk/return characteristics;
  • Fund costs must be "reasonable";
  • Funds chosen for the plan must represent the best interest of the plan and its participants; and
  • Participants need to receive appropriate educational materials to help them undestand the funds' investment and risk characteristics. 
But, after looking at the CFDD's list of mostly negatively performing, high-risk, high-fee, unrated funds that invest in everything from derivatives to junk bonds and currencies, I have to ask myself: What in the world makes any of these funds a prudent choice for a defined contribution plan?

In a non-1940 Act setting many of these kinds of funds are available only through private placements to "qualified investors" with at least $1 million in investable assets. All 1940 Act funds are legally required to funds maintain certain levels of liquidity and must conform with SEC-specified auditing and reporting requirements. But just because these "liquid alternative" funds are a little less risky and a little more transparent than their hedge fund cousins doesn't make them appropriate choices for DC plans, where they would be available to novice investors who might choose them without fully understanding what they're getting into.

Caveat emptor may be appropriate in the defined benefit and high net worth space, but an industry where most participants still don't understand basic investment principles, plan sponsors and advisors should think thrice about letting these hedge-funds-in-mutual-fund-clothing into their plans.

Friday, January 7, 2011

Altneratives & Public Pension Funds: A Questionable Mix

by Jeff Briskin
President, Briskin Consulting

An FBI raid on hedge fund managers Level Global and Diamondback Capital Management in December of 2010 and the revelation that the state of Massachusetts pension fund had invested $66 million with these managers once again raised questions about the prudency of including hedge funds in state pension fund portfolios.

Massachusetts officials quickly noted that the pension fund hadn’t actually lost money from Level Global and Diamondback and these investments comprised only 2% of total assets, according to a December 28 Boston Globe article. However, the raid reminded pundits of the $30 million the pension fund lost in 2007 when Sowood Capital Management failed, and the $50 million loss the state took in 2006 when Amaranth Advisors went under.

Granted that some of the pension fund’s other hedge fund managers performed extremely well during this period, the question is not necessarily whether pension funds should be investing in hedge funds at all, but how does a pension committee evaluate what makes them prudent choices?

Do hedge funds meet ERISA’s fiduciary standards?

ERISA requires all pension fund managers to make sure that costs are reasonable, that investments are prudently managed, and that all portfolio management decisions are made solely in the best interests of the fund and its participants. This in itself would not preclude investments in hedge funds, because they can play an important role in reducing the overall volatility of a portfolio by generating returns that are uncorrelated with current market conditions.

Do they live up to their reputation?

When hedge funds can help temper the overall volatility of a pension fund portfolio they are doing their job. The best hedge funds aren't necessarily those that dramatically outperform the broader market in bull markets. Rather, the true value of hedge funds comes when the market is gyrating in reaction to economic and political events. Successful hedging strategies can anticipate rapid declines in the market, resulting in greater protection against losses.

However, this performance comes with significant risks. Most hedge funds are established as privately held limited liability companies and are not registered with the SEC. Thus, they are not subject to the same level of industry scrutiny and disclosure requirements as mutual funds and other registered investment companies. Also, the cost of investing in hedge funds is generally much higher than investments in stocks, bonds and mutual funds.

How much higher?

Many hedge fund charge a flat 2% investment management fee plus between 10%-25% in so-called ‘performance fees’ that are taken directly out of gross returns. These costs can take a considerable bite out of an investor’s total returns.

A costly illustration

The HiAlpha Fund charges a 2% annual management fee and a performance fee of 20% of investment returns applied to both gross asset values and gross performance. In 2010, the Fund earns 13% in a year net of all fees.The gross returns add back the 2% management fee and adjust for the 20% of gross returns paid to HiAlpha’s manager. This means the gross returns are equal to 18.75% ( [13%+2%] / [100%-20%]). Total fees paid to HiAlpha are 5.75% (18.75%-13%). Thus, the investor’s net return is 13%. In this scenario, HiAlpha’s manager walks away with nearly a third of the gross returns.

Not to mention fund-of-funds costs

Most pension funds don’t invest in individual pension funds. Instead, they use so-called ‘funds of funds’ offered by banks and institutional investment advisors.
Typically, pension fund managers pay higher fees to fund-of-funds managers to cover both the management fees of underlying hedge funds and the fund-of-funds manager’s own advisory fee. For these added costs, the fund-of-fund's manager is supposed to take on the due diligence and fiduciary oversight over the underlying individual hedge funds on behalf of the pension fund manager.

While this may sound good on paper, it’s doesn’t always work in practice. Indeed, both Level Global and Diamondback Capital Management are fund-of-funds managers whose questionable and potentially illegal business practices drew the FBI’s attention.

So, should pension funds include hedge funds?

Unless the U.S. government fully requires all hedge funds to register with the SEC and comply with its disclosure requirements (something unlikely to happen with Republicans controlling the House of Representatives), pension fund managers will have to either continue to use funds-of-funds or conduct their own due diligence on individual hedge funds.

This is not an easy task. Most hedge funds managers are notoriously resistant to disclosing their so-called ‘business secrets’ to potential investors. Yet, no pension fund should rely on stock RFP responses, sales presentations and performance figures alone. Every aspect of the company, from the backgrounds of its senior managers to the vendors it uses for trading, banking and reporting, should be vigorously examined and evaluated.

Fund-of-funds managers should be treated with the same level of scrutiny. Just because these funds are offered by a bank or a institutional investment advisor doesn’t mean that their due diligence processes are comprehensive or fail safe. Of particular concern to pension fund manager should be any potential conflicts of interest in the way these funds evaluate and approve individual hedge funds. Even if certain managers pass the fiduciary muster, pension fund manager still need to weigh the costs and risks of investing in these funds, especially if there may be other, less expensive and less risky ways for a pension fund to add hedging strategies to their portfolios.

Such as?

It is possible to emulate hedge fund performance by allocating a portion of a the portfolio to mutual funds with market-short and market-neutral strategies. While their managers might not deliver the same potential level of alpha and volatility-reducing benefits of the best hedge funds, they offer greater liquidity and, as investment companies registered with the SEC, provide a higher degree of protection for investors. And the cost for this performance may be significantly lower.

Remember who you are investing for

It’s important for pension fund managers to remember that the purpose of their fund is not to deliver Warren Buffet-like results. A pension fund is designed to fund current and future retirement benefits for retired employees. While nearly all investments carry some level of risk, losses due to fraudulent or improper business practices—and fiduciary negligence on the part of pension fund managers who are supposed to identify these risks—aren’t acceptable at all. Particularly to the taxpayers who will have to pay to make up for any underfunding of pension liabilities resulting from these losses.

©2011 Jeffrey Briskin & Briskin Consulting. All rights reserved. Content in this article is current as of its publication date and does not constitute legal or investment advice. Please consult with your legal or compliance department before implementing any recommendations discussed in this article.

Tuesday, August 17, 2010

What Plan Sponsors Don't Know May Hurt You

by Jeffrey Briskin
President, Briskin Consulting

At a recent Boston-area networking event, I was speaking to the newly hired HR Director for a startup biotech company. As her company's designated plan sponsor, she was very interested in the findings of the Briskin Consulting Study of Small Retirement Plan Sponsors, particularly those that revealed plan sponsors' concerns about meeting their fiduciary responsibilities.

She related a story from her own experience. Never having served as a plan sponsor before, she called the financial advisor for a large bank broker-dealer that had originally sold the plan, seeking information on ERISA's latest guidelines on investment fee disclosures. The advisor quickly transferred her to the company's 'retirement knowledge center,' where she spent an hour being bounced from rep to rep until finally she was told that she should speak to an ERISA attorney. After this episode, she vowed to begin a search for a new provider as soon as possible.
Unfortunately, her situation is all-too common among many small-plan sponsors. While larger plans benefit from dedicated client service teams and customized investment policy statements and investment lineups, smaller companies are often given boilerplate plans with fixed fund lineups and 'Rep of the Day' client service. Too often, the calls they do receive are sales pitches for new funds, rather than requests to be of service.
Many plan providers still think investment education and plan compliance are the biggest issues of concern to plan sponsors. But this is not necessarily so. According to the Briskin Consulting study, plan sponsors consider themselves to be reasonably knowledgeable about investments, retirement planning, and the "bread and butter" aspects of plan management such as the plan's features and non-discrmination testing issues.
But it's what plan sponsors don't know that worries them. Three out of four respondents confessed that they lacked significant knowledge of ERISA fiduciary requirements, and little over half felt that they had adequate knowledge of the administrative and investment fees associated with their plan.

Considering that 59% of respondents had less than five years of experience serving as a plan sponsor for any company, it's understandable that respondents wouldn't consider themselves experts on these complex issues. If they do gain knowledge in these areas, it's probably through self-education, as plan sponsors have low opinions about the quality and quantity of fiduciary advice they receive from plan providers and advisors.

As expected, providers scored highly when it came to providing information and advice on investment options and on non-discrimination testing issues. But plan providers fell short on providing clear and concise information on fees and updates on ever-evolving ERISA and Department of Labor regulations. Indeed, more than one respondent wrote that their provider's idea of providing regulatory news was to send them directly to the Department of Labor web site, leaving them to fend for themselves in a sea of bureaucrat-ese.

Why is this dearth of fiduciary and regulatory education and assistance important? Because it leads to plan attrition. Roughly 92% of respondents cited poor client service as a key reason for initiating a search for a new provider and nearly 60% cited poor fiduciary and regulatory guidance. Compare this to the 49% who felt that poor investment performance was a critical factor for starting a search. Plan sponsors have become used to variability in investment results; the market meltdown following the financial crisis levelled the investment playing field, making performance and benchmarking less of an issue.

Instead, plan sponsors are hearing about participant lawsuits and are worried that their company may be next. They're looking for guidance and assistance to help them understand what it means to be a fiduciary in a volatile market and a regulatory environment that is likely to become more complex and demanding. If they can't get this information from their plan providers, who will they turn to? Chances are, a provider who is willing to fill in this information gap. Is your firm up to the challenge of retaining--or poaching--these plans?

You may download the full Briskin Consulting Study of Small-Retirement-Plan Sponsors for free. Jeff Briskin is available to present additional findings to your organization in person or via the web. Contact him at for information or to learn more about his new Fiduciary Insights plan sponsor education series.

Thursday, May 20, 2010

Seeking Advice: Insights from the Briskin Consulting Study of Small-Retirement-Plan Sponsors

by Jeffrey Briskin
Principal, Briskin Consulting

While most sponsors of smaller defined contribution plans are generally satisfied with their plans, nearly a third are considering changing plans due to poor client service, a lack of fiduciary support and substandard participant educational resources. And most companies that are considering switching plan providers are rejecting commission-based bank and wirehouse broker dealers in favor of dedicated retirement plan providers, third party administrators (TPAs) and registered investment advisors (RIAs), according to preliminary findings from a new study just released by Briskin Consulting.

The Briskin Consulting Study of Small-Retirement-Plan Sponsors is based on a survey of 112 respondents serving as 401(k) plan sponsors at companies with less than 200 employees. Plan sizes ranged from $208,000 to $11 million in assets, with an average size of $1.44 million as of December 31, 2009.

Small plans...large opportunities

Since most businesses in America are smaller, privately owned enterprises, it's no surprise that smaller defined contribution plans comprise the largest and most fluid segment of the retirement marketplace. Generally, these plans are sold through RIAs, TPAs and registered representatives within banks and wirehouses, although a growing percentage are sold directly through small-business retirement groups within investment firms and insurance companies.

Many surveys of retirement plan sponsors focus on quantitative data, such as investment performance, enrollment rates and deferral percentages. The Briskin Consulting Small-Retirement-Plan Study avoids this well-traveled ground in favor of providing insights into the psychographic factors that affect plan sponsors' satisfaction and concerns with their role in managing their plan--and participants' expectations.

Typically, in a smaller company, an HR professional serves as plan sponsor, and managing it is only one of his or her many responsibilities.  While retirement plan salespeople often try to target the company's CFO or COO, it's their multi-tasking benefits/payroll/recruiter/counselor who often wields the greatest  influence when it comes time to review the company's current plan and conduct a new search. 

In the past, retirement plan providers were evaluated mainly on the variety and performance of investment options, the availability of call centers and online services, and their ability to create strategies to encourage enrollment and increase contributions.

In today's post-recession economy, companies are evaluating all benefit plans with an eye toward reducing costs and maximizing value added service. Plan sponsors in particular are asking for a higher level of education and advice to help them comply with ever-evolving regulations and tightening standards of fiduciary oversight.

Today, exceptional client service is far more important than online services. Five-star funds are of lesser value than sound strategies for managing investment risk. Increasing enrollment is less critical than helping employees make the right decisions while they're accumulating assets, when they're preparing for retirement, or when they leave the company.

Retirement plan providers who can address these issues and allay plan sponsors' worries stand a far better chance of retaining the business even when other factors--such as a change in senior management--spur calls for a new search.

This article summaries several key findings of the Study. To download a free copy of the full Study, go to or send an email to
Why sponsors worry

If we compare the issues that worried plan sponsors in 2007 versus those that concern them today, we see that the same subjects predominate their thinking.

(Click for bigger image)

Enactment of the Pension Protection Act of 2006 created a whole new set of regulations that plan sponsors were expected to understand, evaluate, and implement in their plans, placing a heavier emphasis on meeting fiduciary obligations. Cost containment also became a major issue. Understandably, these are the greatest concerns among plan sponsors, with 87% concerned about complying with regulations, 74% concerned with meeting their fiduciary obligations and 81% facing pressure from management to keep plan costs under control.

These concerns have increased since 2007, as the recession has taken its toll on the well being of  companies and their employees while at the same time setting higher expectations for fiscal efficiency and corporate accountability.

It's also interesting to note that issues retirement providers once considered to be of critical importance, such as investment performance, enrollment percentages, and discrimination testing, weren't primary areas of concern to sponsors in 2007 and are even less so today, thanks to  automated enrollment, slimmed down workforces, and increasing performance commodization among investment classes.

Plan satisfaction is high--but there's room for improvement

In spite of the increasing level of worries among plan sponsors, the good news for incumbent providers is that 63% of plan sponsors are generally satisfied or very satisfied with their plans. Only 29% are either dissatisfied or very dissatisfied with their plans. The remaining 8% have no opinion either way.

(Click for bigger image)

Sponsors are most pleased with the overall quality of client service and compliance and operational support they receive from their providers, as well as the diversity of investment options. Not unexpectedly, however, the majority of sponsors are unhappy with the performance of these options, the level of fiduciary and regulatory guidance they receive, and the lack of transparency around fees. They also see room for improvement in participant education and find everyday plan administration to be increasingly complex and time consuming.

Why do companies switch providers?

The time and effort involved in switching plan providers can create strong resistance to calls for change, even among smaller companies. Fifty seven percent of survey respondents indicated that their company has no intention of changing plans over the next three years and 10% haven't even thought about it. Of the remaining one third who are either likely to switch plans or are in the process of evaluating new providers, most cite poor client service  (92%), lackluster participant education programs (62%) and substandard fiduciary and regulatory advice (61%) as their main reasons for their decision to look elsewhere.

(Click for bigger image)

Interestingly enough, the performance and selection of investment options and plan costs are not among the most important factors in motivating a search. And, contrary to common belief, dissatisfaction among plan participants has relatively little influence over the decision to change providers.

Who sold them the plan...and from whom will they get their new plan?

Most plans in companies with less than 100 employees were sold through TPAs, banks/wirehouses, and RIAs. Plans in larger companies were sold primarily through TPAs, investment/financial services firms, and RIAs.

Of the one third of plan sponsors who are either in the midst of evaluating providers or considering making a change, it is interesting to consider their likelihood of using (or not using) certain kinds of providers. Note that respondents could enter responses for more than one category.
  • 46% intend to using a dedicated 401(k) plan provider within an investment or insurance firm (such as Fidelity or Vanguard)
  • 34% intend to use a TPA or outsourced benefits firm
  • 27% intend to use an RIA or other independent advisor 
  • 12% intend to find a plan through a wirehouse or bank
  • 6% indicated other sources (investment consultants, etc.)
Sponsors were also asked to indicate which kinds of providers they would not use. Bank/wirehouse brokers (73%) were far and away chosen as the least likely to be consulted, followed by RIAs (36%), investment/insurance firms (32%) and TPAs (30%).

Lessons for retirement plan providers

Contrary to common belief, investment returns do not drive satisfaction with or sales of small retirement plans. The post-recession market has made performance less of an issue. Instead, in an environment demanding a higher level of corporate accountability and where participants are still recovering from double digit losses in their 'nest eggs,' plan sponsors are demanding a higher level of retirement expertise, exceptional fiduciary support and effective participant-related investment and retirement planning advice from plan providers.

Firms that wish to win this business from smaller companies need to put fund lineups on the back burner and lead with client and participant service, emphasizing their ability to help plan sponsors ease their administrative burden and meet their fiduciary obligations.

Broker dealer reps within banks and wirehouses stand the most to lose in this environment, as the commission-based nature of their business precludes their ability to offer fiduciary-level investment advice. In addition, these reps rarely have the deep understanding of 401(k) regulations that sponsors are increasingly demanding from their providers.

In this environment, TPA firms and institutional retirement groups within investment and insurance firms have a stronger chance of winning 401(k) plans in this space. Fee-based RIAs who can supplement their ability to provide fiduciary advice with an ability to provide advice and assistance on plan management issues and exceptional participant education programs may also have a better chance of becoming their clients' trusted retirement advisor.

In addition to the Study, Jeff Briskin is available to present additional findings to your organization in person or via the web. Contact him at for information.