In a simpler time for retirement plans, say, 15 years ago, a major overhaul to an unsatisfying defined contribution (DC) plan investment lineup went something like this: Find a more skilled mutual fund provider, shut down participant access to the program for a month, ask the legacy fund manager to cash out all the participant accounts, and map the participant balances into the new manager’s funds.
Today, it is much more complicated. DC plans are much bigger than they used to be, some have moved from mutual funds to more complex investments, investment managers are keeping a tighter hold on the governance reins, and expectations are such that most expect to be back up and running in just a few days. Place those requirements into a background of markets that frequently move a percent or more in a single trading session, and it is no surprise that sponsors are adding transition management to the conversion’s critical path.
Portfolio transitions in the defined benefit (DB) world are complicated enough. A sponsor decides to replace a manager handling millions of dollars in plan assets, or adjust the plan’s strategic asset allocation. The account needs to be moved to a new manager, quickly and quietly so as not to tip off the market, and, during the process, the assets should remain invested, typically through buying futures to create the right market exposure.
By comparison, a DC plan transition calls for participation by many more parties. “Beyond the legacy and target investment managers and the custodian, you have to bring in the plan’s recordkeeper and any other advisers or providers,” observes Brandi Wust, Senior Consultant in the New York offices of Towers Watson.
“In a DB transition, the biggest factor is often the risk that you’ll miss a big move in the market while the portfolio is being liquidated and invested in the new strategy,” she adds, “but, in a DC transition, the operational risks are more important. The numerous participant accounts have to be handled correctly, and everything has to be moved, reconciled, and back up and running for trading during a blackout period of just one to three days. Yes, you have to consider market risk, but it’s the one thing you can’t control.”
Another complexity is the fund accounting, and the need to strike net asset values (NAVs) at the end of trading days, notes Kal Bassily, Head of Global Transition Management at Convergex in New York. “We have to communicate all we’ve done throughout the day, be that buys or sells of shares, bonds, or mutual fund shares. Even if there is a blackout period, funds still have to strike an NAV.”
Sponsors tear down and rebuild their DC plans predominantly for two reasons. “Studies say that DC participants lag the performance of DB participants by 100 to 200 basis points, and sponsors are interested in closing that gap,” says Paul Sachs, Principal and Senior Consultant within the Mercer Sentinel Group, which advises sponsors on operational issues, including transition management. “Some of that is lower cost, and some is investment performance.”
“There also is a move to best-of-breed investment structures,” reports Josh Cohen, Defined Contribution Practice Leader at Russell Investments, Tacoma. “In large plans, that often means custom target-date funds”—going to investment managers whose services may not be available in mutual fund form—“and adopting those is a major project requiring a transition manager.”