With the regulatory spotlight shining on fiduciary roles thanks to new, tougher rules from the DOL, more defined contribution (DC) plan sponsors are hiring third parties to handle their plan investments. Called 3(38) investment managers for the sub-section of the ERISA law that defines their role, they are responsible for overseeing the plan’s investment strategy, including selecting, monitoring and replacing the funds in the investment menu.
Why hire an outside investment manager? Evaluating investment options and determining which are appropriate for the plan and easy for participants to understand is complex. Some DC plan sponsors simply aren’t comfortable making critical decisions like choosing a target date or balanced risk fund, or weighing actively vs. passively managed options. What’s more, hiring a third-party manager frees up sponsors to focus on their business, not the business of managing their plan’s investments.
Once embraced primarily by large, frozen defined benefit (DB) plans, this practice — also called outsourcing the chief investment officer, or OCIO — is moving down-market to smaller and mid-sized DC plans. In fact, OCIO arrangements work for plans of all sizes, according to Willis Towers Watson. A recent brief from the global benefits and risk management firm discusses this and other common misconceptions about OCIO and why they should be challenged.
Myth #1: Plan size matters. Actually, it doesn’t. An OCIO relationship can benefit larger organizations with in-house investment managers, because outsourcing a portion of that function may help keep the team from being spread too thin. For the same reason, it’s also beneficial for smaller organizations where employees are likely filling multiple finance roles, only one of which might be managing the DC plan’s investments. In both situations, partnering with an OCIO provider can free up vital resources and potentially improve investment governance and outcomes.
Myth #2: Delegating investment management means losing control over the plan and investments. This simply isn’t true. Plan sponsors and investment committee members still determine investment objectives and constraints within which the OCIO works. Moreover, ERISA law says plan sponsors are ultimately responsible for being prudent in selecting the OCIO. As such, sponsors retain fiduciary responsibility even if they outsource fiduciary investment management functions.
Myth #3: OCIOs are conflicted. Yes, OCIOs both advise on and implement the investment strategies they recommend. However, conflicts of interest can be avoided. The fees for management and advice are separate and transparent, and OCIOs can only retain their fees if they perform their duties as promised. Additionally, the onus is on OCIO providers to identify, acknowledge and manage such conflicts should they arise — not the plan sponsor.
Myth #4: OCIOs aren’t proven. While OCIO arrangements are relatively new, the fiduciary management concepts behind them, such as multi-asset strategies, heightened governance and real-time portfolio decisions, have been in practice in pension plans for more than a decade.
Myth #5: OCIO is too expensive. Partnering with an OCIO provider may actually save money in the form of lower investment fees, and again, free up time and resources at all levels of the organization, especially among key personnel.
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