Questions Sponsors Need to Ask When Hiring a 3(38) Fiduciary

DC plan sponsors should examine a potential investment manager’s approach to governance as well as investing, and they should review past performance results.

Hiring a 3(38) investment manager fiduciary to oversee the investments in a retirement plan lineup is an important step that sponsors should take seriously, experts say. They need to ensure that they are looking at the right criteria to judge and assess a potential 3(38) fiduciary.

Even if they are moving from 3(21) investment adviser fiduciary services to 3(38) services, they need to do detailed due diligence, says Gregory Metzger, senior consultant at North Pier Search Consulting.

“I would be pretty confident that most organizations moving from a 3(21) fiduciary to a 3(38) fiduciary are doing so because the adviser has suggested they make the move,” Metzger says. “They may feel comfortable with their current relationship and just make the change, but we think that is imprudent. Even if they are moving upmarket with an organization they have been comfortable with, they still need to have a process to assess various criteria, and all of this should be documented, and one of the most important things they need to consider is the fiduciary’s track record. We create a composite of 3(38) client menus going back at least five years and look at the investments they used and their returns. We also do this on a quarterly basis and compare them to their peer groups.”

Michele Brennan, U.S. defined contribution (DC) solutions leader at Willis Towers Watson, says, “Those who hire a 3(38) fiduciary experience the most successful relationship when it is truly a strategic partnership between the sponsor and the fiduciary.

“To help find the right fit, plan sponsors should be looking at an outsourced chief investment officer [OCIO]’s approach to governance in terms of plan design and investments,” Brennan continues, “while examining their expertise in the management of DC plan investments, their decisionmaking process, workflow and fee/service model.”

Brennan agrees it is also important to examine the 3(38)’s or OCIO’s performance in meeting the strategic initiatives and needs of the plan. She also says sponsors should consider how easy the providers make it for participants to navigate the plan.

When examining a 3(38)’s experience and qualification, Brennan suggests asking the candidate for case study examples of their work and references from other clients. “This helps the plan sponsor determine if they are a thought leader in terms of plan design, governance and investments,” she says.

Metzger also looks to see if the staff members are licensed properly and if the firm has bonding insurance. “That gives you insight into the financial stability of the organization,” he says.

It is also important to determine whether the 3(38) fiduciary is tailoring its investment recommendations to each plan, rather than offering a cookie-cutter approach, says James Sampson, director at Hilb Group Retirement Services.

“I have seen a number of standalone 3(38)s that just load up the plan lineup with index funds,” Sampson says. “Or, they are just looking at lowest-cost funds. I don’t know what value that offers a plan sponsor. They should be using multiple fund companies for the lineup to find the best of breed.”

Metzger reminds sponsors that even after they hire a 3(38) fiduciary, they are required under the Employee Retirement Income Security Act (ERISA) to monitor the investment manager.

Jeff Gratton, managing director and chief marketing officer at SageView, says he warns plan sponsors hiring 3(38) fiduciaries that this service is often sold as risk mitigation.

“That is not the case, really,” he says. “It is less about risk mitigation and more about freeing up the time of the committee members to focus more on plan administration, employee education and plan design, rather than investments. This can be very valuable for many sponsors.”

“If the plan sponsor isn’t sophisticated, that can be challenging, because all of the information is coming from the 3(38), so we recommend that if they are not comfortable assessing the information on their own that they hire a third party to monitor and assess the 3(38),” Metzger says.