The Prudent Fiduciary

Scott Pritchard | Principal

A look at the major issues that are shaping fiduciary best practices today.

Fiduciary Prudence in a Post-2008 World-Part One

February 2009

As fiduciaries responsible for the investment of assets on behalf of others, I doubt that many of us will miss 2008. Being a fiduciary always carries with it a tremendous sense of responsibility, but the market environment of this past year made our roles that much more challenging.

Yet we have to remember that fiduciary prudence is not about results. It is about process. And process is about achieving long-term success in the face of occasional bumps (or craters, as the case may be) in the road.

ERISA requires that fiduciaries of qualified retirement plans act “…with the care, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of and enterprise of a like character and with like aims.” (Section 404(a)(1)(B))

So what care, prudence and diligence does a “prudent person” use in a post-2008 environment? Over the next several weeks, I will lay out what I believe to be the critical components of a prudent post-2008 process.

Component #1: Providing a strong “do-it-for-me” solution.

The vast majority of participants do not want to manage their own assets and most do a poor job when they are forced to do it. Prudent fiduciaries recognize this and in 2009 and beyond will include a strong “do-it-for-me” solution in their process.

The prolific growth of target-date and lifecycle funds is in direct response to this realization and most plans now offer some sort of “do-it-for-me” solution. But not all of these funds are created equal and fiduciaries should ensure that they can clearly answer the following questions:

  1. Does the fund follow a logical glide path? Of course, fiduciaries must first ensure that they understand each fund’s glide path. Is there an equity-to-bond mix that is appropriate for participants at all risk levels and time horizons?
  2. Do you fully understand the funds’ underlying holdings? In the wake of the Madoff scandal, transparency is paramount. Fiduciaries should have a clear understanding of where participant assets are ultimately invested.
  3. Do you know the bottom-line expenses of each fund? Transparency of fees should include not only the funds’ expense ratios, but also the fees associated with the underlying holdings and any wrap fees or revenue-sharing.
  4. Do participants truly understand how to use the funds? A target-date or lifecycle fund is intended to provide full diversification in a single-choice option. Yet many of the analyses we conduct for plan sponsors reveal participants holding multiple target-date funds in one portfolio, or holding a lifecycle fund alongside a number of individual funds, thus reducing the intended diversification benefit.

As we enter 2009, I think it’s safe to say that all prudent fiduciaries now offer some sort of “do-it-for-me” solution. But are your target-date or lifecycle options truly a strong offering? Do they meet the standard of what “…a prudent man acting in a like capacity…” would offer?

Participants would certainly be interested in the answer to that question.

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