PLANSPONSOR - October 2017 - 39

The draft IPS spells out specifically
what benchmarks will be used to evaluate
the funds in various peer groups in
the plan, but it refrains from detailing a
decision process to retain or terminate an
investment option. According to fi360, the
" watch list decision " cannot be made by
a formula. Thus, the draft IPS expressly
states that " extraordinary events do occur
that may interfere with the investment
option's ability to prudently manage
investment assets. It is the committee's
confidence in the investment option's
ability to perform in the future that ultimately
determines the retention of an
investment option. "
The IPS Protects ... Until It
Doesn't
Jim Phillips, president of Retirement
Resources in Boston, makes a crucially
important point about the value of an
IPS by asking a simple-sounding question:
" Does having an investment policy
statement increase liability, or decrease
liability? "
If you chose the first answer, he
says, you are correct. And if you chose the
second, you are also correct. The point is
that, as a rule of thumb, sponsors should
be very careful about the use of " shall, "
" must " and " will " statements.
" In case the reason isn't obvious, just
picture a plaintiff's attorney with a big
smile on his face, " Phillips says. " Let's
say your IPS says a fund will be removed
if it underperforms its benchmark for
three consecutive quarters. If you haven't
followed your IPS, you could be financially
responsible for any losses incurred
subsequent to the point at which the IPS
required that fund to be removed. "
Even if the IPS is not a required document,
recent analysis from professors
Max M. Schanzenbach of Northwestern
University School of Law and Robert H.
Sitkoff of Harvard Law School considers
how a carefully crafted IPS can benefit
everyone involved in the retirement
investing space touched by it.
One takeaway from the pair's analysis,
titled " Fiduciary Financial Advice to Retirement
Savers: Don't Overlook the Prudent
Investor Rule, " is that, like so many of the
rules overseeing the delegation of tax-qualified
retirement plan dollars, the modernized
IPS ought to be " principles-based
rather than prescriptive. " The researchers
observe that no type of investment is categorically
permissible or impermissible in
the eyes of investment regulators. " Instead,
a fiduciary must evaluate risk tolerance and
investment goals; choose a commensurate
level of overall portfolio market risk and
expected return; and avoid wasteful, diversifiable
risk. Because of the multiplicity of
relevant considerations ... application of
the prudent investor rules is specific to an
investor's circumstances. Accordingly, the
rules permit a wide variety of investment
techniques. "
What Not to Consider Matters
A fund manager personnel change has
become a common trigger to put a fund
on a watch list, Morningstar reports in a
recent research paper, " The Aftermath of
Fund Manager Changes. "
According to the paper, this might
not be an effective indicator. Researchers
Madison Sargis, quantitative analyst, and
Kai Chang, director, in Morningstar's
Chicago office, argue that the mutual
fund industry " handles succession planning
far better than investors react to such
changes. " When it comes to defined contribution
(DC) plans, their analysis finds, this
phenomenon is in no small part driven by
IPS documents prescribing certain actions
when specific triggers get pulled.
KEY POINTS
* Although an investment policy statement is not a required document
for a DC plan, most plan sponsors have them in place.
* To create or update a plan's IPS, begin by reviewing all plan
documents that pertain to investing in any way.
* Plan sponsors should look to strike a balance between specificity and
flexibility in the IPS.
* Focus more on naming what the IPS requires than expressing exactly
how specific duties must be met.
PLANSPONSOR.com October 2017 39
" Does having
an investment
policy statement
increase liability,
or decrease
liability? "
Investment policy statements are far
from standardized, but the research shows
that many mention, in some capacity, the
plan's general objectives, and investment
structure and criteria. Further outlined
will be the ongoing investment monitoring
and evaluation processes, which
may include the fund-manager change
trigger. And once a fund manager has
been placed on a watch list, it may take
only one or two quarters of slightly belowbenchmark
returns to lead to a fund's
potentially disruptive dismissal.
The Morningstar research finds " no
relationship between any type of management
change and future returns. " In fact,
the highest-performing funds are those
" given the benefit of the doubt by investors "
when there is a management change
or other transitory issue.
The analysis concludes, it is much
more sensible to adopt and enumerate a
flexible approach for monitoring manager
changes, formalizing that in the IPS, and
striving first and foremost to identify
whether the change represents a true
policy modification or simply a shift in
transitory personnel. -John Manganaro
http://www.PLANSPONSOR.com
PLANSPONSOR - October 2017

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