DC plan sponsors: what do you believe?
As an institutional investor, you don't need to have the same beliefs as us. But you need to have beliefs.
Investment beliefs are a series of high-level principles and opinions, unique to each Committee, that guide decision-making and supersede the personal views of individuals. Investment beliefs are not a checklist to be applied to every decision, rather, they can be used as a guide for making decisions that often require balancing multiple, inter-related factors.
The creation of a robust set of investment beliefs for your defined contribution (DC) plan can enhance plan governance, guide decision-making and provide a valuable touchstone in times of uncertainty. A belief set saves time as it cuts down on debate and speeds the decision-making process. It creates continuity across the organization in times of staff, structure, or market changes. Beliefs can capture and classify learnings from the past in order to increase the likelihood of investment success in the future. And beliefs prepare for the unexpected by establishing the universe of response.
The power of orchestration
Let's talk about that last point—the universe of response. No matter what size your DC plan is, the team managing it is organizationally diverse and complex. Whether that team is all internal, all external, or a combination of both, it is vital that everyone is working toward the same objectives, under a shared agreement of how to best help employees save enough to fund their future retirement. The last thing you want is for one part of your team structure to be working toward one outcome, while others are focused on different priorities.
Beliefs should work equally well during good times and bad. They should serve the plan during bull markets and work like an earthquake drill for pear-shaped events. We all know what we believe, your team can say, so when the unexpected happens, we're all prepared to act appropriately.
We're all human after all
Committee members are human too, and not immune from the myriad of behavioral biases that plague plan participants, such as recency bias, anchoring, loss aversion, and availability bias. Human behavior often leads to predictable but irrational decisions, which adversely impact actions and performance. Behavioral biases are exacerbated in a group setting like a Committee meeting and can lead to emotionally-driven decisions, conflict, and group think.
Codified investment beliefs can help alleviate behavioral factors by serving as a north star to guide you toward your outcome. They provide an impartial and strategic foundation for making appropriate decisions in times of stress or uncertainty.
They inform organizational priorities and document the organization's DC plan design and investment philosophy. They also come in handy when a member of the Executive Committee emails about why there's no Biotech Fund in the 401(k) plan.
Establishing investment beliefs
Establishing investment beliefs is an iterative process between you, your plan stakeholders, and potentially your investment consultant.
To do this right requires a disciplined, no-shortcuts approach. This process generally starts with the Committee being asked to complete an investment beliefs survey to help identify and define existing investment beliefs relating to the DC plan. Differences in beliefs are identified, debated and settled, and a collective set of beliefs are ultimately documented in a statement of investment beliefs—which will help inform decisions going forward.
Here are some questions we're asked on a regular basis, along with our time-tested answers:
We have disagreement right now. How can we get to an agreed upon set of beliefs?
Of course you have disagreement, because every plan has a complicated ecosystem – different types of participants, fiduciaries from across the organization acting on their behalf, vendors, a Board of Directors and on and on. It would be a miracle for all those different constituents to just coincidentally have the same beliefs. There are disagreements today, whether you realize it or not. And right now, people are acting according to those conflicting beliefs. One says, I believe in active management. One says, I don't. These are both valid points of view and should be debated through a process we call the negotiated settlement. The negotiated settlement is the final committed decision. Maybe that final negotiated belief says, The Committee believes in active management, and can tolerate periods of underperformance. Then, in the future, when a new Committee member says, "At the last company I worked at, we only offered passively managed funds in the DC plan," you can say, "I appreciate your perspective, but that doesn't align with our beliefs and we don't think that's best for our participants."
Can a belief set help manage litigation risk? Or is it just another thing to get us into trouble?
The former. While nothing can guarantee a plan sponsor won't be sued, DC plans can mitigate litigation risk through good governance, and establishing beliefs improves plan governance by enhancing discipline, consistency and institutional memory as Committee members change. Some plans simply allow their actions to imply what their belief set is, which can lead to contradictions, making it more difficult to demonstrate that a logical and consistent process was followed with respect to governing the DC plan.
Your Investment Policy Statement (IPS) may need to be updated to better align with the Committee's documented investment beliefs. For example, if an investment belief is that a long-term perspective should be taken to monitor investment results, and the IPS focuses on a shorter time period, the two are in conflict.
What if I have both a defined benefit and a defined contribution plan? Do our investment beliefs need to be the same?
While DB and DC plans may have separate and distinct objectives that necessitate certain structural differences and requirements, they can still be guided by a similar set of investment beliefs and principles. Ideally, plan sponsors should apply a consistent set of investment beliefs as possible across both the DB and DC plans, where appropriate.
In closing, we're sharing some of our in-house defined contribution investment beliefs.
- Creating a simple investment lineup for participants is more important than offering too many choices.
- Most participants are not experienced or well-informed investors, so investment menus should be structured to simplify their decision-making process.
- A manager's past performance should not be the most important consideration when evaluating an existing manager or when selecting a new manager for the plan's investment menu.
- When past performance is considered, focusing on their long-term track record is most appropriate.
- With the support of our investment consultant, we are able to identify active managers that are capable of outperforming their benchmarks, net of fees.
- Creating a tier-based investment structure will accommodate the needs of the majority of participants, including those who prefer active management.
- Alternative investment strategies would benefit participants, but because of the complexity, only as part of pre-constructed portfolios, such as white-label or custom target funds.
- ESG (Environmental, Social and Governance) factors positively impact risk and/or return attributes, so we should consider these along with non-ESG factors when evaluating a manager's investment process.
- Since DC plans have become the sole source of retirement income for many, committees should consider strategies to help participants manage their spending in retirement.
- Costs matter and need to be effectively managed.
We're sharing a sub-set of our defined contribution investment beliefs to show our commitment to this approach. You may disagree with them. We can accommodate that. But hopefully this belief set can serve as a strawman you can react to—a significant step to get you beyond the blank page. Because whether you believe it or not, beliefs matter.