Monitoring Your CAP Advisor
Sizing up fees, performance and fiduciary issues.
August 8, 2011
This is the fourth installment in my five-part series on fees and performance in defined contribution (DC) plans. In this post I discuss CAP advisor fees and performance. Many smaller plan sponsors use an advisor (an agent or broker of record) to assist their CAP members without understanding what to consider in evaluating performance. Sponsors also need to ensure that the advisor is doing only what has been authorized.
Advisors provide four basic areas of service: member retirement planning, assisting with financial education, investment advice and sponsor governance assistance. Retirement planning support is provided by the record keeper in the form of information and tools that help members in understanding investment concepts, identifying their risk tolerance and selecting an appropriate asset mix. However, sponsors recognize that some members simply don’t have the time and prefer to use an advisor to ensure they have considered all the elements of retirement planning.
Are they offering advice?
Advisors however may also go a step further and provide advice in addition to asset mix recommendations such as which investment option to use and when. Investment advice may benefit some members but results in additional potential legal and financial risks for the sponsor. In some cases the sponsor may also rely on the advisor to assist in governance and selecting investment options or provide reporting to assistance in administering the plan, all of which should also be considered in the evaluation.
Section 3.4 of the CAP Guidelines recommends that sponsors, in choosing or referring members to an investment advisor should ensure the advisor has an appropriate level of knowledge, expertise and should be independent of any other service providers. Section 6.2 of the CAP Guidelines also recommends that sponsors clearly establish the criteria used in selecting the advisor and periodically use it as information in reviewing an advisor’s performance.
In some cases sponsors are not even aware that the advisor is providing investment advice — a risk from a governance and fiduciary perspective. While offering investment advice may appear to be a good idea, plan sponsors tend to shy away from it because of the added fiduciary responsibilities and legal risks.
The objective in monitoring and assessing the advisor’s performance is important for a number of reasons and should be done formally and on a regular basis to ensure all (and only) the services agreed to are being satisfactorily delivered and at a reasonable cost.
The fees for the advisor’s services are applied to all investment options (excluding Guaranteed Investments (GIs) and daily interest investment options) as a part of total composite paid members. Advisor fees of 0.3% to 0.9%, depending on the size of the plan, are not uncommon and often represent a substantial portion of the total cost paid by the members. Members with investments of $100,000 -$400,000 may pay $300 -$3,600 annually for advisory service over their working life.
The advisor fees are paid regardless of whether or not a member uses the advisory service. The amount the advisor receives also automatically increases annually as the amount of the member’s investments increase through contributions, earnings or increases in the market value. The advisor may also earn fees from a group benefit plan if applicable.
Members who only or primarily invest in GIs or daily interest accounts but make use of the advisor services are getting these services at little or no cost. Conversely members invested in equity and fixed income-type otions may not use the services of the advisor but pay the cost.
Evaluating an advisor’s service performance can be a difficult qualitative exercise because information on member usage and the type of service provided is often limited or doesn’t exist. Direct feedback from members, the administrator or surveys can be useful in assessing performance but may be costly and difficult to interpret. Assessing the quality of actual investment advice is also a challenging task, which will require specific information and member feedback.
In some cases the advisor fees are not disclosed separately and neither the sponsor nor member is aware of the actual annual cost.
Therefore a good starting point in evaluating advisor performance is to request the amount of fees the advisor actually receives each year and obtain information on the type and quality of services provided to the members. In other words, the sponsor should understand what services are being provided by the advisor and to whom as well as whether or not the costs are reasonable. Providing the advisor with a list of information needs and a reporting format is necessary in most cases. Increases in the amount the advisor actually receives year-over-year should also be explained and justified (i.e., is there more or better service?).
In summary, there is nothing wrong with providing CAP members investment advice through an advisor but it’s important to understand the additional fiduciary responsibilities, risks and to understand who is paying the cost. Sponsors should ensure that an advisor is not providing CAP members with investment advice unless this has specifically been authorized.
Because of the nature of the relationship with certain service providers it is advisable to have an experienced and impartial consultant assist in evaluating the performance of the record keeper.
In Part V of this series, I will discuss fees and performance issues relating to equal treatment of plan members and fee issues to consider when converting from a DB to DC plans.