Selecting and monitoring the right suite of investments in a defined contribution (DC) plan lineup is a core part of a plan sponsor’s fiduciary responsibilities. However, with the plethora of investments available today, both standalone and in asset allocation portfolios, the resources needed to effectively perform the required due diligence can overwhelm even the most sophisticated plan investment committee. Many plan sponsors look for help in understanding the options available to them and ensuring that those on the menu are the best fit for a particular plan and its demographics. Three Morgan Stanley executives, Ed O’Connor, head of Retirement & Insured Solutions; Paul Ricciardelli, head of Investment Advisor Research; and Jeffrey Stein, Stable Value Senior Research Analyst, sat down with Alison Cooke Mintzer, editor-in-chief of PLANSPONSOR, to discuss this topic and the commitment Morgan Stanley is making to help plan sponsors navigate the investment landscape and fulfill their fiduciary duties through adding investment research resources, improving model portfolios and offering 3(38) fiduciary services.
PS: Ed, could you speak about the state of the industry and what you see as the most significant differentiators for plan sponsors as they look for help?
O’Connor: Defined contribution plans are one of Americans’ primary retirement savings vehicles. It is incumbent on investment professionals to raise the bar in order to give the participants in DC plans the best opportunity to retire with dignity.
More and more institutional capabilities are being delivered directly to participants. For example, here at Morgan Stanley, using the asset allocation advice of our Wealth Management Global Investment Committee, we have constructed target-risk and target-date models specifically for retirement plan sponsors to deliver to participants.
PS: Where does the investment solution concept fit with the broader retirement plan context, such as the qualified default investment alternative (QDIA) or automatic enrollment?
O’Connor: There will always be participants who want to make their own choices, so plan sponsors need the help of an investment professional to create a solid foundation for those choices. Those investment professionals, when backed by strong resources such as ours, are well-suited to meet that need and provide plan sponsors with the advice they deserve. Those same specialists with that deep bench are also in a great position to help plan sponsors create customized QDIAs. I see more and more QDIAs being customized. It’s amazing how quickly target-date funds (TDFs) have evolved over the last handful of years. And now we are seeing more and more customization of those solutions.
If you are customizing a target-date solution for a plan, the plan sponsor should look at the participant profile: Do I have employees who are generally younger or older? Do they keep their money in the plan or do they move on? Do we also offer them a pension plan that helps to augment their DC plan? I actually believe over time this standard of care will become a common feature of DC plans with target-date solutions.
PS: What makes 3(38) fiduciary services a better option for plan sponsors, particularly those offering custom solutions?
O’Connor: Plan sponsors have a lot on their plate, and turning over investment selection responsibility to a firm that focuses on managing wealth for institutions can allow them to allocate their attention to other parts of their business. It also can provide those plan sponsors with additional means to manage their fiduciary responsibilities.
PS: What should plan sponsors look for when selecting a 3(38) provider?
O’Connor: When plan sponsors give discretion to their investment professional, they no longer have the fiduciary responsibility for the individual decisions concerning the construction of the core menu and/or models. Their fiduciary responsibility is to monitor the investment professional. By the way, this means you really should assess the depth of the bench of the investment professional. This is too important to be about one person. It must be a team of highly skilled professionals.
At Morgan Stanley, we have a long heritage of investment excellence. Paul and Jeff will do a better job than I can explaining the impressive resources we have built over the many, many years within the home office. But that is only part of the story. The other is the great professionals we have across the country—these are our Corporate Retirement Directors and Graystone Consulting teams. It is their job on a day-to-day basis to serve these plans and deliver the appropriate solutions that Paul, Jeff and I provide for them.
PS: You have both a risk-based and a target-date offering. With all the movement toward target-dates—and you mentioned the growth there being considerable—for whom is risk-based the right solution?
O’Connor: We hear from both plan sponsors and our financial advisers that it is very clear that there still is a base of employees who want risk-based models. There are many reasons for this. For some, it may be that the age demographics of their organization are more homogenous, and hence a risk-based QDIA is more appropriate. For others, it could be that their investment committee simply has a fundamental philosophy more aligned with a risk-based solution than a glide path solution. I do not believe there is a right and wrong answer to this one.
PS: Paul, can you give an overview of the Investment Advisor Research group that you oversee?
Ricciardelli: We have 30 investment professionals who are dedicated to the analysis of third-party asset managers in traditional and alternative asset classes. We have a view on a wide range of investment offerings, providing our financial advisers and clients with opinion-based analysis of over 1,100 specific strategies that are offered as separate accounts, mutual funds or in exchange-traded fund (ETF) format. Stable value is the newest component of our analytical coverage.
The majority of the individuals on the team are senior analysts who are specialized in a particular area of coverage, such as domestic or international equity, fixed income or nontraditional investments.
Our investment process is extremely comprehensive and is composed of initial as well as ongoing components. The team is dedicated to looking beyond past performance and developing a view on a broad range of factors on each manager we cover. These areas include their investment philosophy, research capabilities, portfolio construction and business operations. Key to the process are one-on-one meetings with key investment personnel to understand and evaluate their capabilities.
We do quite a bit of holdings-based analysis to understand the risks, central tendencies and factor exposures of the strategies we cover. Our ultimate objective is to determine whether we believe a strategy can meet or exceed its investment objectives.
PS: How does that due diligence integrate with the types of investment options available—mutual funds versus ETFs versus collective trusts?
Ricciardelli: This is done at the strategy level. We’re less concerned about the packaging. Regardless of whether the strategy is a mutual fund, ETF or separate account, we are more interested in how the engine runs than the chassis that it sits on. We develop an opinion on each strategy and how its investment process works. This includes its portfolio construction process, risk controls and the analytical resources that its investment team is using.
Stein: In the case of stable value, there are additional operational due diligence needs because of the nature of these investment vehicles.
PS: That is a good point. Paul, can you describe why that need was so apparent?
Ricciardelli: We felt that it needed a higher level of care because of the nature of stable value as an investment vehicle. We also analyzed the DC market in 2013, and the allocations to stable value just jump off the page. The Plan Sponsor Council of America (PSCA) reported that approximately 13% of DC plan assets were allocated to stable value in 2012. For these reasons—and the fact that, to our knowledge, no other firm with the resources of Morgan Stanley has an analyst dedicated to stable value—we felt this would be a unique opportunity to bring our intellectual capital to this space.
PS: So, Jeff, you came to Morgan Stanley and are now a Senior Research Analyst dedicated to stable value. Talk to me a little about your research process and evaluation of the product.
Stein: I have leveraged my experience structuring stable value wraps to develop the due diligence process here at Morgan Stanley. I start by looking into how the product is structured—i.e., insurance company product versus bank collective trust. This provides the framework for the types of questions I’ll ask during my on-site meetings with stable value providers. From there, the process is two-pronged: I need to understand how the portfolio is constructed using the investment contracts and the underlying market value portfolio.
The investment contracts provide the book value guarantee and are offered by an insurance company or a financial institution. When looking at the investment contracts, I focus on several items. At the firm level, I look at the guarantor(s)’ credit quality and its/their commitment to the stable value business. At the product level, among other things, I look into how the crediting rate is generated, how plan sponsors can move between stable value providers, and the limitations for participants moving in and out of stable value products.
I then look underneath to the market value portfolio, which is governed by investment guidelines. The portfolio is a medium duration, high-credit-quality multi-sector fixed-income fund that is typically composed of anything from treasuries, corporates, agency mortgage-backed securities (MBSs), asset-backed securities (ABSs) and commercial mortgage-backed securities (CMBSs).
The due diligence process is designed to identify any potential areas of concern for the plan sponsor and to communicate my findings to the financial advisers with client-approved reports specific to each product I review. My goal is to provide our financial advisers with the additional knowledge and tools they need to help their clients fulfill their fiduciary duties in regard to stable value funds.
O’Connor: This is a classic example of the intensive due diligence we offer to those who serve as a plan’s fiduciary. We really want to make sure they understand what’s going on and know what questions to ask. On their own, plan sponsors cannot be expected to know all the questions that need to be answered.
PS: What are the areas of stable value that plan sponsors should really be focusing on? What are the questions that plan sponsors most need to ask and have answered?
Stein: I think first and foremost they need to look at the performance. At the end of the day, that’s what the participant is going to experience. But that’s not the end of the story. They need to understand what is driving that performance. For example, what types of risk is the underlying asset manager taking? Where is the portfolio positioned on the credit and yield curve? Is the plan sponsor being compensated due to single guarantor credit risk?
Plan sponsors must be aware of the product’s liquidity provision, which may also be a driver of performance. While bank collective trusts typically have a 12-month put, insurance company products often make annual installment payments over a set period of time. At the end of the day, the plan sponsor has to understand the exit mechanism and the potential portability of the product.
Sponsors must also take note that there are competing fund provisions in the investment contracts, which are intended to prevent plan participants from arbitraging the stable value fund. For example, if a participant wants to move from a stable value fund to another short-duration bond fund, the participant has to move into equities for 90 days. This is known as an equity wash.
Additionally, plan sponsors need to be aware of what they can and cannot communicate to their participants, to avoid triggering certain provisions in the investment contract. For example, disseminating adverse communications that would directly cause outflows from the fund may be problematic.
This is just a subset of the details that a plan sponsor should be considering when evaluating and selecting a stable value product.
O’Connor: The bottom line is that we understand what plan sponsors need to know about the structure of stable value products. Our Corporate Retirement Directors and Graystone Consulting teams can deliver Jeff’s reports to plan sponsors and help them make the right decisions about the solutions to offer their participants.
To bring it back to what I said in the very beginning, the bar is being raised, and we need to help plan sponsors bring the best investment solutions possible to each and every participant. We work on that each and every day.
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