Answering Another Key Question in a Request for Proposal
Contributor Scott Simon argues why he doesn’t think alternative investments are good choices for retirement plans.
Last month’s column dealt with a question often asked in a Request for Proposal. An RFP is a formal document in which an employer, such as the sponsor of a 401(k) plan that’s governed by the Employee Retirement Income Security Act of 1974, or ERISA, solicits proposals from qualified firms to perform third-party services such as investment management, recordkeeping, or other plan administration.
Nonprofits, including endowments and foundations as well as other pools of money subject to fiduciary edicts, may also choose to issue an RFP, and requirements for those RFPs should not be any less exacting than for ERISA plans. According to best practices, a requestor should go to market and issue a new RFP every three to five years in order to ensure that its plan is receiving services that, among other things, are cost-effective.
Last month’s column identified the question that a plan sponsor always asks respondents answering an RFP for investment management services in a 401(k) plan: What’s your investment philosophy?
This month’s column identifies another question often found in RFPs issued by nonprofits, including endowments and foundations. More particularly, this question asks respondents for their philosophy regarding alternative investments.
One of the tenets of modern prudent fiduciary investing--originating with the 1992 Restatement (Third) of Trusts and subsequently codified in the 1994 Uniform Prudent Investor Act and its various progeny, including the 2006 Uniform Prudent Management of Institutional Funds Act (or UPMIFA)--is that no investment is considered imprudent per se to include in a portfolio.
However, any given investment can become imprudent when its inclusion in a portfolio is considered unreasonable or inappropriate within the context of a particular set of facts and circumstances.
I don’t favor the use of alternative investments (including, say, hedge funds and private equity) for a whole host of reasons.
It is a truism of Wall Street that the more complex an investment product and the more difficult it is to truly understand the product (including all its hidden costs and conflicts of interest), the greater the compensation that will be paid to the salesperson peddling it. And alternative investments are almost always very complex. Fiduciaries, especially those responsible for pools of assets at nonprofits, must be alert to this--but ideally will retain an advisor wise to the ways of sellers of alternatives.
W. Scott Simon is an expert on the Uniform Prudent Investor Act, Restatement (Third) of Trusts and Title I of ERISA. He provides services as a consultant and expert witness on fiduciary investment issues in depositions, arbitrations and trials as well as written opinions, which are described here. Simon also serves as a discretionary fiduciary investment advisor to retirement plans at Retirement Wellness Group. For more information, email Simon at firstname.lastname@example.org or email@example.com. The views expressed in these articles do not necessarily reflect the views of Morningstar.