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The Secret Role Manager Selection Plays in 401(k) Plans

Last Updated: June 10, 2024

Investment Performance in Retirement Readiness

Have you wondered why your company’s 401(k) plan isn’t preparing your workforce for retirement? More specifically, what percentage of your employees would you guess are on track for retirement? The most common answer we hear from HR execs is only 15-20%.

 

401(k) plans are the backbone of retirement savings for millions of American workers. They are one of the only widely available benefits to help employees save and invest for their future. However, many plans are failing to prepare their participants for retirement. One reason may be poor Investment Performance.

 

Investment performance is one of the three key drivers of retirement readiness. The returns generated by your participants within your retirement plan directly influences their ability to achieve their retirement goals. It’s more than just a metric for success, it’s a pillar of your employee’s financial security.

As we discussed at length in a recent article, even seemingly small improvements in investment performance can dramatically improve the retirement readiness of your employees.

Your plan’s ability to properly equip participants for retirement greatly depends on the decisions of your fiduciary committee. Central to the equation of investment performance for your participants is the investment lineup, or the options you provide to participants. They depend on your committee to make sound choices about the plan’s investment offerings.

Manager Selection in Plan Lineups

Despite the weight of fiduciary investment decisions, many committee members may not realize the wildly important, yet severely misunderstood role manager selection plays. Investment managers wield significant influence over the returns realized by participants. It is a pivotal decision in the plan’s management and oversight. Today, we are going to take a closer look at manager selection and how it holds the power to impact participants’ financial future.

 

As said before, returns generated within retirement plans extend beyond mere numbers on a statement; they translate into tangible outcomes in retirement. Each dollar earned contributes to participants’ retirement readiness. While positive performance can provide peace of mind, underperformance can lead to delayed retirement.

 

By examining the nuances of this process and its implications for participants, we can uncover the pathways to enhancing retirement readiness through improved investment decisions.

The Purpose and Track Record of Manager Selection

Manager Selection Defined
That’s a lot of inside baseball, let’s start at the beginning – what is manager selection?

Manager selection is simply the decision of choosing which investment manager to use for a given asset class. In this context, the managers seek to outperform an index benchmark. This is commonly referred to as active management. For some asset classes, there may be hundreds of different managers from which to select. So, how do you decide which is best for your plan?

 

When building an investment lineup for a 401(k) plan, you would generally offer a dozen or more asset classes to your participants. That means a dozen or more decisions of manager selection.

Manager vs. Fund: Before we continue with the nuts and bolts, you may be wondering why we refer to “manager” selection, rather than “fund” selection. Rest assured; they mean the same thing. When it comes to 401(k) plans, we are investing at an institutional level – billions of dollars are flowing through retirement plans across the country. As a result, the manager you select may be offered in a variety of vehicles, such as a mutual fund or Collective Investment Trust (CIT). Either way, they are overseen by a management team of investment professionals, referred to as fund or portfolio managers. They are entrusted with your participant’s hard-earned dollars and directly influence the performance of the fund. Hence, manager selection.

The Goal of Manager Selection:

At its core, the goal of manager selection is to choose investment managers who will generate returns for plan participants in excess of the benchmark assigned to the asset class.

The Poor Performance of Manager Selection:

Despite its importance and ubiquity, manager selection has, mostly, fallen short of expectations. We have known for some time that the majority of active managers have struggled to consistently outperform their index benchmark over time. Annual industry reports from both S&P (S&P Indices versus Active Scorecard or SPIVA) and Morningstar (Active vs Passive Investing U.S. Barometer Report) show that most active managers fail to outperform their passive index benchmark over time.

Our PCI Investment Lineup versus Passive Scorecard (ILPS) report has shown that the poor performance extends to managers selected for 401(k) type plans. So, despite its potential to add performance, when viewed in totality, manager selection has failed to achieve its goal.

This subject becomes even more challenging due to opaque performance reporting regarding manager selection. Frequently, plan fiduciaries simply don’t know how their manager selection has performed for their participants.

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To learn more, check out our 3 ½ top, yet surprisingly uncommon, tips that can help your investment lineup reach its potential.

The Challenge of Successful Manager Selection:
Finding active managers who consistently beat their index is a difficult task. If you are a retirement plan fiduciary committee member, chances are you rely heavily on a plan adviser to guide you in the selection process. Successful manager selection is multifaceted, requiring in-depth expertise, time, consideration, and diligence.

How the industry has responded:

Over time, as evidence has mounted that the majority of active managers fail to consistently beat their benchmarks, investors have increasingly turned to index funds (i.e., passive strategies).

 

The plan adviser industry seems to be in agreement. In response to the skepticism of active managers who successfully beat their index benchmark, there is now an anti-manager selection camp that many 401(k) plan advisers have joined.

 

Today, much of the industry has given up on the idea of successfully selecting active managers. This makes some sense as the fees are generally lower in passive index funds as there is less need for active research and resources. Additionally, passive strategies mitigate the risk of manager underperformance.

In our view, not doing it is better than doing it poorly. And doing it poorly has unfortunately been too common. Many advisers simply aren’t equipped with the expertise, time, or resources to do it well.

So, why bother?

You may be asking yourself, if it’s so difficult and many advisers lack the expertise and resources to do it well, then why do it at all? Why not just settle for the index fund for each asset class in the plan lineup?

 

Because successful manager selection has the potential to add 25-50 bps (.25-.50%) annually to investment performance. And that is a powerful contributor to your participant’s retirement readiness.

 

In fact, as the illustration below shows, an additional 50 bps per year can add hundreds of thousands of dollars to a participant’s account over a working career and years of income in retirement.

Bottom line: Successful manager selection can add the investment performance your participants may be missing to get on track for retirement.

At PCI, we have a documented track record of manager selection in 401(k) plan lineups. Our commitment is to get your employees on track for retirement and we understand the importance of investment performance in that endeavor. In fact, we proudly report our manager selection performance. You can find our updated quarterly performance here.

Fiduciary Committee Oversight

The delegation of manager selection is a crucial decision that fiduciary committees often face. While some committees may have the expertise and resources to handle manager selection internally, most opt to outsource this responsibility to plan advisers. Regardless of the chosen route, ensuring due diligence in the selection process is essential to safeguarding participants’ interests.

Lastly, robust reporting and accountability mechanisms are essential for maintaining transparency and trust within the retirement plan ecosystem. Choosing the right plan adviser to help you along the way is critical. An effective plan adviser should do more to get your employees ready for retirement than any other plan service provider you hire.

Regular transparent reporting on your plan’s actual manager selection performance allows fiduciary committees to monitor the effectiveness of the chosen managers and make informed decisions for plan participants’ benefit. Moreover, your plan adviser should be accountable for their manager selection and, ultimately, the outcomes your participants receive. Effective manager selection can and should add significant value.

If you know your employees are not on track for retirement, investment performance may be the reason. If so, manager selection is likely the cause.

How 401(k) Fund Changes Can Hide Poor Investment Performance

Have you wondered if you have the complete investment performance story for your 401(k) plan? You aren’t alone. Watch this on-demand webinar where we discuss how fund changes can hide poor performance.

WRITTEN BY

Pension Consultants, Inc.

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WHAT’S INSIDE

1

A good plan measures
three key elements:
contributions,
investments, and fees.

2

A good plan serves
employees and
employers.

3

Fiduciaries have a
responsibility to make
reasonable decisions
with their employees’
best interests in mind.

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1

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2

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3

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