• / Free eNewsletters & Magazine
  • / My Account
Home>Practice Management>Fiduciary Focus>That Old Fiduciary Feeling

Related Content

  1. Videos
  2. Articles
  1. Get a Handle on Your Portfolio

    Ahead of Portfolio Makeover Week, Morningstar's Christine Benz offers tips to alleviate common concerns over retirement readiness, inflation, allocation, and more.

  2. 401(k) Pros and Cons

    These plans offer investors many benefits in saving for retirement, but they also have their drawbacks.

  3. Know These Thresholds of Social Security Benefits

    Andrew Salata of the Social Security Administration offers tips for how retirees can manage age and income limits to optimize their Social Security payouts.

  4. No Shortage of Investment Challenges Today

    From high correlations to macroeconomic uncertainty to rock-bottom interest rates, investors face a large number of headwinds today, says Morningstar's Shannon Zimmerman.

That Old Fiduciary Feeling

There are few things more rewarding in professional practice than explaining a certain plan investment concept to a participant and seeing the light bulb go on.

W. Scott Simon, 05/02/2013

"I'm sorry, but I haven't understood a thing you've said in the last five minutes."

For an instant I was dumbstruck, but then I leaned back, relaxed, and smiled. I value honesty, and a clearly stated sentiment, belief, assertion, or whatever is something that I--perhaps more than most people--respect. But I must admit  I was taken aback for a moment by what this person said to me in her direct and unblinking way.

The person was a participant in the retirement plan that my partners and I, along with our implementation team, were transitioning as the new investment manager pursuant to section 3(38) of the Employee Retirement Income Security Act of 1974 (ERISA). I was conducting a one-on-one meeting with the participant during the conversion process, and her response was in reply to my recurrent "Does that make sense to you?" question.

When transitioning any retirement plan, my partners and I have always held the strong belief that it's best to put in a lot of time up-front during a longer-than-normal conversion process. This is to help ensure that plan participants "get it" about the fiduciary duties that we owe to them and to the plan, and have a basic understanding of our investment philosophy. A good portion of that time involves one-on-one meetings with plan participants who sign up for them because they want more information and attention than can be provided in a group meeting.

Taken as a whole, these one-on-one meetings can become quite exhausting over the course of a few weeks, just one week, or even a single day. The participant mentioned above was the 12th, or perhaps even 15th, participant I had advised that day. I had talked so much that I was spitting cotton at the end of the day.

Although these meetings can be exhausting, they are nonetheless exhilarating (at least to me). Unlike any other interaction with plan participants, they allow our firm to really get the "pulse" of the new plans we are transitioning so that we can see what's really on the minds of plan participants. Of course, at this stage of our careers we could readily outsource this activity to a third party, but my partners and I (helped by our own employees) would rather be on the front lines/in the trenches/where the rubber meets the road, literally looking plan participants in the eye.

In those face-to-face (and occasional hand-to-hand) meetings with plan participants, we tell them that we are fiduciaries (pursuant to ERISA section 3(38)) to them and their beneficiaries, which is why all the model portfolios we offer on our investment menu are broadly and deeply diversified to reduce risk, and are low cost to boot. Both factors serve to keep more money in the pockets of plan participants (which they immediately understand). We feel the seriousness of the fiduciary duties we owe to plan participants perhaps even more profoundly because our firm's name appears as part of the portfolios' moniker.

Although plan participants may not always understand the concept of diversification much beyond the "don't put your eggs in one basket" warning, they do seem to readily grasp implicitly that risk and return go hand-in-hand: You cannot expect to have a shot at earning higher returns by holding low-risk investments. In short, they freely agree that there's just no "free lunch" in investing. That's true--except in cases where portfolios are broadly diversified ("horizontally" across the asset classes represented in a portfolio) and deeply diversified ("vertically" within each asset class represented in a portfolio) to reduce risk. In such cases, a reduction in return does not go hand-in-hand with a reduction in risk; in fact, risk is reduced while return is not.

While I have noticed that participants respond well in our meetings when I use the phrase "broadly and deeply diversified portfolio to reduce risk," I caution them to beware of a nicely turned phrase. Indeed, words such as "stable," "value," and "guarantee" are part of the siren song used to lure participants toward the rocks of stable value funds. I then use a real-life example to show them the practical effect of what it means to have a broadly and deeply diversified portfolio that reduces risk.

For the year 2008, our firm's 60/40 model portfolio was down approximately 22% in value. In our periodic face-to-face meetings with participants at some large plans that our firm manages, they told us that, although they weren't thrilled with that state of affairs, they'd like to roll over their plan accounts at previous employers, which were down, say, 35% in value and, oh by the way, their spouses sure would like to work here because then they could roll over their plan accounts, which were down, say, 45% in value.

When a plan account is down 22% in value rather than 35% or 45%, the financial hole that a participant has to dig itself out of is significantly less. The practical import of this is that such a participant will "get back to even"/"breach the surface" more quickly (i.e., where it was before the loss in value) and therefore will be able to resume more quickly its march toward accumulating wealth and be able to participate to a greater degree in the up market that must, by definition, inevitably follow every market bottom (e.g., March 8, 2008). A portfolio down 35% in value must gain 54% to get back to where it started, while a portfolio down 45% in value must gain 82% to get back to where it started. But a portfolio down 22% in value must gain only 28% to get back to even. In short, a broadly and deeply diversified portfolio that reduces risk usually goes down less in value during market downturns and requires less return during market upturns to erase the deficit.

Notice in the previous two paragraphs that I don't use the word "loss" with plan participants but rather the phrase "down in value." When discussing the idea of risk in 2008 with them, most told me that they "lost" a lot of money. At that point, I stopped them and asked if they bailed out of their investments and went to cash. Most of them replied, no, they just "rode it out." I then explained that I had to ask them that question because a "loss" implies that they sold all the holdings in their plan account and went to cash.

On the other hand, a portfolio that's "down in value" a certain percentage means that a participant doesn't sell out but, in fact, maintains it intact to "fight another day." (By the way, it seems that the participants who "rode it out" and avoided selling low in a panicked down market in order to preserve the value of their plan accounts and therefore prosper in a rising market were helped in that by simply throwing their unopened quarterly statements in the drawer.)

There are few things that I find more rewarding in my professional practice than explaining a certain plan investment concept to a participant and seeing the light bulb go on. The participant referenced in the opening of this month's column had such a moment as I overcame my inability to communicate with her and described a certain concept in language that she was able to understand. She responded to that at the end of our meeting by saying: "God bless you, sir." That can be taken in a religious--or even a non-religious--way. In either case, though, I take it as a fiduciary--to be more precise, a discretionary fiduciary that's an investment manager pursuant to ERISA section 3(38). It's that old fiduciary feeling of shouldering legally meaningful responsibilities and relevant associated liabilities in order to protect plan participants (and their beneficiaries) in accordance with the great "sole interest" and "exclusive purpose" rules (as well as the others) enshrined by Congress in ERISA section 404(a)(1).

W. Scott Simon is an expert on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule). He is the author of two books, one of which, The Prudent Investor Act: A Guide to Understandingis the definitive work on modern prudent fiduciary investing.

Simon provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. He is a member of the State Bar of California, a Certified Financial Planner, and an Accredited Investment Fiduciary Analyst. Simon's certification as an AIFA qualifies him to conduct independent fiduciary reviews for those concerned about their responsibilities investing the assets of endowments and foundations, ERISA retirement plans, private family trusts, public employee retirement plans as well as high net worth individuals.

For more information about Simon, please visitPrudent Investor Advisors, or you can e-mail him at wssimon@prudentllc.com

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar.

©2017 Morningstar Advisor. All right reserved.