(b)est Practices: Plan-Level Investment Selection/De-Selection

March 28, 2014 (PLANSPONSOR.com) - Maintaining an investment menu is a somewhat different task than building one from scratch.

While there are many common elements, we will focus on the practical aspects of managing an existing menu.  The authors will assume that most readers of this column are plan sponsors who already have an investment menu. 

Step one is to step back.   Try to take the perspective of an outsider coming in and scrutinizing your plan’s investments.  Bear in mind that this could happen at any time.  Take stock now, before an examiner or plaintiff’s attorney arrives on the scene.  Start with the big picture and then get more granular.

Does the menu fit your current employee demographics?  If your plan has been around for a while, has the menu kept step with changes in your workforce?  If your employee base is aging, are there options that are suitable to meet their investment needs, such as conservative allocation or income funds? 

Do your current offerings reflect the level of your employees’ financial literacy? If you have had an influx of younger workers or ones with language challenges, how have you adapted to that?  Do you offer age-based or risk-based allocation funds or model portfolios to help them pick a suitable mix?

What is the interest rate exposure of your plan’s income funds?  The past 30 years has generally brought handsome returns to bond fund investors.  However, the pendulum may be ready to swing back the other way.  Find out the “duration” of your bond funds.  This will tell you the size of the potential loss a bond fund will experience if rates rise.  For example, a bond fund with a duration of 10 could lose approximately 10% of its value for each 1% rise in interest rates.   Make a decision now about whether you should reduce your menu’s duration exposure—before the rates “hit the fan”.

Employee education programs can help address the issues outlined above, and many others.  A future column will address this topic.

What’s next?  A high-level review may point you in the direction of making some menu revisions.  Searching for new funds is a screening process.  If you work with an adviser, he or she will perform many of these steps, and this article may equip you to be a better collaborator in this process.  If you don’t work with an adviser, you (and any other plan fiduciaries) will be responsible for making these investment decisions. 

Depending upon the size of your plan and the vendor you are using, various amounts of support may be available.  Definitely take advantage, but bear in mind that plan vendors do not accept fiduciary status, so they are not obligated to represent your plan’s interests.  They are free to stack the deck with funds on which they make more money, so it’s important that you openly discuss the rationale and potential conflicts associated with any ideas they bring to the table.

There are subtle differences between screening for new funds and screening existing options for continued inclusion.  With new funds, you start with a clean slate and can screen for the best available fund.  Bear in mind, that some funds may not be available on your provider’s platform, may be closed to new investments, or may have minimums that may be an issue.  There may also be economic considerations.  Most plans’ administrative costs are partially offset by “revenue sharing” from investment providers.  (Revenue sharing will be the topic of a future column.)  You will have to work with your provider to see what restrictions or incremental costs may be associated with adding certain new funds.  Having that discussion in advance can help you to focus your search and will save you time.

Screening existing funds for continued suitability is similar to screening new candidates, in the granularity described below, but whereas you should be quite picky about new funds you add, you may have good reason to be more lenient in retention decisions.  This is because all good managers go through periods of underperformance.  There are varying explanations, such as a manager with a more conservative style may have a poor peer ranking during a “risk-on” market phase, but may still be a completely suitable option within the context of a 403(b) menu.

Get granular.  First, make sure your decisions are consistent with your Investment Policy Statement.  (This will be the subject of a future article.)

Have a disciplined process for screening your funds.  Look at a variety of information, such as peer rankings, risk level, historic returns during various market types, manager tenure, style consistency, asset growth or shrinkage, governance record, and any non-systematic risks such are geographic or sector concentration.   There is no single criterion you can look to that will fulfill your fiduciary “duty of care.” 

For example, some people will judge funds exclusively by their Morningstar ratings.  It’s a fine organization, but even it would encourage you to do a deeper dive.  A five-star fund could have just lost its long-time manager, or it could have just drifted into a new investment category, or it may have had asset inflows or redemptions that will impact future results.  Likewise, FI360 scores are a useful top-level screening tool, but it takes a deeper dive to make a prudent decision.

Weigh risk metrics (such as standard deviation and beta) as heavily as you weigh performance.  For example, a fund with a historic return of 10% may be less prudent to add (or retain) than a fund with a 9% record, if the 10% fund is much riskier.  Metrics such as alpha and Sharpe Ratio help to quantify risk-adjusted returns.

Fire a fund if you have lost confidence in it, but don’t pull the trigger too quickly if a fund meets most of your criteria but is just going through a slump.  There have been many instances where our patience has paid off, and there have been many instances where we have seen other fiduciaries ride a fund down and then fire a manager just before the “magic” returned. 

In summary:   Successful investment menu management is part art and part science.  There isn’t a single formula or black box that can do your job for you.  Investment performance is hugely impactful on long-term retirement saving results.  As a fiduciary, you owe it to your plan participants to do an excellent job on their behalf, pulling in whatever resources you need in the process.


Jim Phillips, President of Retirement Resources, has been in the investment industry for more than 35 years, the past 18 of which have been focused in the area of qualified retirement plans.  Jim worked for major national investment firms for 14 years before “going independent” in 1990.  Jim is an Accredited Investment Fiduciary, has contributed to two books on 401(k), and his articles have been published in Defined Contribution Insights, PLANSPONSOR’s (b)lines and ASPPA’s 403(b) Advisor, and Jim is a RetireMentor on MarketWatch.com. His work has been acknowledged with multiple Signature Awards from the PSCA, he has been named to the 2012 and 2013 list of Top 100 Retirement Plan Advisers, by PLANADVISER Magazine, and he was a finalist in 2012 for the Morningstar/ASPPA 401(k) Leadership Award. Jim has been a frequent speaker at national conferences, including SPARK, ASPPA, AAO and the PLANSPONSOR and PLANADVISER National Conferences.

Patrick McGinn, CFA, Vice President of Retirement Resources, is a CFA charterholder and has been in the securities industry since 1993. In addition to the Chartered Financial Analyst designation, he is an Accredited Investment Fiduciary and a member of the Boston Security Analyst Society. Together with Jim, Patrick has co-authored a number of articles which have been published in industry publications on topics about managing successful 401(k) and 403(b) plans. His work has been acknowledged with multiple Signature Awards from the PSCA, and he has been named to the 2012 and 2013 list of Top 100 Retirement Plan Advisors, by PLANADVISER Magazine. He was a finalist in 2012 for the Morningstar/ASPPA 401(k) Leadership Award.

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.