The Well-Tempered Investment Policy Statement

Transcription

1 FIDUCIARY FOCUS: The Well-Tempered Investment Policy Statement This material is an educational discussion of Investment Policy Statements which provides ideas and suggestions on this topic and should not be construed as legal advice. Plan sponsors and others should consult their own counsel and designated advisor, if applicable, for specific guidance on their particular circumstances. Executive Summary Plan sponsors can meet their ERISA fiduciary obligations without having an investment policy statement (IPS) in place; however, a well-written investment policy statement provides a solid framework for managing your plan s investment portfolio. The IPS is a governing document that sets directives and constraints. An investment policy statement is commonly organized into sections covering: Description of the plan Purpose of the IPS Roles and responsibilities General investment objectives Processes for portfolio construction Current investment lineup Participant education and communication Investment and IPS review processes This article will examine each of these areas in greater detail. By recognizing the crucial role of the IPS and making sure that it is current, fiduciaries maximize their effectiveness in serving plan participants and may help mitigate a source of fiduciary risk. All content 2010 Jeffrey Briskin and Briskin Consulting. All Rights Reserved. A WHITE PAPER FROM RIDGEWORTH INVESTMENTS SEPTEMBER 2010

2 Contents n2 Comprehensibility is Key Common Elements of an IPS n3 Description of the Plan Purpose of the IPS Roles and Responsibilities n4 Investment Objective and Strategic Considerations Processes for Portfolio Construction n5 Current Investment Lineup n6 Participant Education and Communication Investment and IPS Review Processes n7 Reinventing the Wheel Not Required Next Steps If There Are Issues If you were thinking about building a new home, you probably wouldn t begin breaking ground without detailed blueprints and a list of construction materials, building permits and a building schedule provided by a qualified contractor. Likewise, participants in your 401(k) plan deserve a strong foundation upon which they can build their own retirement nest egg. This is where an investment policy statement can help. If your plan doesn t have an investment policy statement (IPS), you re not alone. According to studies by PSCA, Hewitt Associates, and BARRA Rogers Casey, less than half of defined contribution plan sponsors have an IPS. Plan sponsors aren t necessarily against the idea; rather, many are simply unaware that such documents exist. After all, plan sponsors can meet their ERISA fiduciary obligations without having an IPS in place. However, a well-written investment policy statement provides a solid framework for managing your plan s portfolio. It outlines guidelines for selecting asset classes and investment options, educating and communicating to participants, and evaluating performance and risk. It assigns roles and responsibilities for conducting these activities, and, most important, provides a set of standardized guidelines that anyone serving in a fiduciary capacity is expected to follow. Comprehensibility is Key While some investment policy statements read like they re written by committees of attorneys and bureaucrats, there is no rule requiring them to be incomprehensible. At the very least, the provisions of an IPS: 1. Should reinforce its role in ensuring that the plan complies with ERISA regulations and fiduciary standards; and 2. Must not conflict with any provisions in the actual plan documents Beyond these basic requirements, there is a great deal of flexibility in how an IPS can be structured and written. However, organizations that are creating their first IPS may want to follow certain conventions that have become standard in the industry. Indeed, unless you have an ERISA attorney on your pension committee, chances are that your firm will not be writing its own IPS, and will instead be adapting a template provided by a retirement plan consultant or investment company. Common Elements of an IPS While the actual language and ordering of content may vary, content in investment policy statements is commonly organized into sections covering: Description of the Plan Purpose of the IPS Roles and Responsibilities General Investment Objectives Criteria and Processes for Portfolio Construction Current Investment Lineup Participant Education and Communication Investment and IPS Review Processes Let s examine each of these areas separately. FIDUCIARY FOCUS: THE WELL-TEMPERED INVESTMENT POLICY STATEMENT PAGE 2

3 Description of the Plan An IPS generally begins by stating the formal name of the defined contribution plan (and the company sponsoring it) that is subject to its provisions. Additional language may: Acknowledge that the plan is expected to be managed in compliance with all required federal and ERISA regulations Emphasize that the purpose of the plan is to offer participants a range of diversified investment options that addresses a wide range of investment timeframes and risk tolerances State that in cases of conflict between the IPS and the plan document, the terms of the latter will take precedence If a company has more than one defined contribution plan (such as separate plans for union and non-union employees) both plans should be mentioned here, unless investment decisions are handled differently. In that case, you may wish to create a separate IPS for each plan. Purpose of the IPS Why is an IPS needed? To make sure everyone responsible for investment decisions plays by the same rules and meets both the plan s and ERISA s expectations. This should be stated in detail. It may also be useful to state the five main ERISA fiduciary requirements: Follow the plan documents Make prudent investment decisions Offer appropriate investment diversification Keep fees reasonable Act solely in the interest of the plan and its participants If a plan is also committed to fulfilling the safe harbor provisions of ERISA 404(c), it should be stated here as well. ERISA 404(c) requires plans to provide participants with information and resources to help them assume greater responsibility for making and executing their own investment decisions. Providing this information provides plan sponsors with a degree of protection against liabilities due to losses in participants accounts. A list of resources that the plan will offer to comply with ERISA 404(c) may be included in the Participant Education and Communication section. Roles and Responsibilities An IPS is of no value unless people follow its guidelines. That is why it s important to list the names and roles of those responsible for making investment decisions in accordance with the IPS. These should include: The plan sponsor and/or others in the company serving on its pension committee A representative of the plan s Trustee Any outside investment consultants or financial advisors Key contacts with other service providers, such as recordkeepers or plan administrators, even if these providers are not involved with investment decisions Finally, this section should specify who has the authority to recommend and approve any changes in investment strategies or options and in the IPS itself. FIDUCIARY FOCUS: THE WELL-TEMPERED INVESTMENT POLICY STATEMENT PAGE 3

4 Investment Objective and Strategic Considerations The investment objective of any defined contribution plan may be stated as simply as: To provide a diversified range of investment options that can help plan participants invest the way they want to achieve their specific retirement goals. Once this is formally stated, a set of general strategies may be articulated that define how this objective will be achieved. These may include: Offering a range of asset classes and styles that cater to participants of various ages and lifestages, risk tolerances and investment knowledge Providing investment options that strive to deliver investment returns that either match or outperform associated benchmarks Keeping investment management fees reasonable These high-level strategies provide the philosophical framework for asset allocation and manager selection decisions employed in portfolio construction. Criteria and Processes for Portfolio Construction This may be the most important section of the IPS. Here, the guidelines for creating a diversified investment lineup should be articulated in as much detail as possible. There are many different ways this can be accomplished. The following represents a possible threestep process that a pension committee might use. Note that this process is more applicable to a startup plan, but its principles may also be applied when changing plan providers or even when reviewing an existing plan portfolio. STEP 1: Analysis First, the pension committee analyzes the demographic characteristics (age, education, investment knowledge, income) of its eligible employees to determine which kinds of investment goals (aggressive, long-term returns, capital preservation, a mix of income generation and capital appreciation) should be addressed by the plan through its inclusion of different asset classes and investment styles. STEP 2: Asset Allocation Using this demographic analysis as a guide, the committee moves on to determine which asset classes to be included in the portfolio. Factors that may be considered: Which asset classes (equity, fixed income, cash, blended) to include Which sub asset classes or investment styles (growth, value, balanced, stable value, high yield, investment-grade) should be included Which asset classes will offer actively managed or passively managed options (or both) The total number of investment options a plan should offer (to meet ERISA 404(c) standards, the plan must offer at least three) The number of options per asset classes Which kinds of investment managers (banks, insurance companies, broker dealers, asset managers) should be considered and which kinds should be excluded Your workforce demographics may determine the quantity of choices in each asset class. For example, a company with a predominantly older workforce may choose to offer a larger variety of fixed income and blended options, while a startup staffed by younger employees may include a broader selection of equity funds. FIDUCIARY FOCUS: THE WELL-TEMPERED INVESTMENT POLICY STATEMENT PAGE 4

5 STEP 3: Evaluation and selection of investment options Next, the committee should define the criteria, processes and resources to be used for researching, evaluating and selecting investment options. Short and long-term investment returns and benchmark comparisons are only two factors to be considered. Members should also consider: The reputation of the investment provider (including any past or pending legal actions) Historical investment risk and volatility Outside resources (such as independent fund rating services) to be utilized The effect of investment management fees on returns The quantity and quality of investment information and educational materials (particularly important to plans wishing to meet ERISA 404(c) safe harbor requirements) If a pension committee plans to use an outside investment advisor to evaluate and recommend investment options, additional language may be included that requires the advisor to disclose: The specific tools and methods the advisor uses to research the options and determine their appropriateness for the plan, based on its objectives Whether the advisor is paid a commission by investment companies What the advisor will do to keep fees reasonable and avoid potential conflicts of interest Current investment lineup Once the investment lineup has been finalized, it may be listed in this section. This is the one section of the IPS that is most likely to be changed as options are added or replaced. A listing might resemble the following, with options assigned to specific sub-asset classes: XYZ Retirement Plan Asset Allocation and Investment Options Last updated 2/15/2010 Asset Class Sub-Asset Class Name of Fund Added to Plan Equity Large Cap Growth LMNO Large Cap Growth Fund 2/15/08 Large Cap Index ABC S&P 500 Index Fund 2/1/08 Large Cap Value XYZ Large Cap Value Fund 2/1/08 Mid-Cap Value GHI Mid-Cap Value Equity Fund 8/3/09 Small Cap Growth AAA Small Cap Growth Fund B 8/3/09 International Equity International Fund ABC Diversified International Fund 2/1/08 Emerging Markets BBB Emerging Economies Fund 2/1/08 Fixed Income High Yield AAA High Yield Fund 8/3/09 Investment-Grade Bond Cash Stable Value Stable Value Fund ABC Intermediate Bond Fund 2/1/08 Blended Balanced Fund PDQ Equity Income Fund 2/1/08 Target Date Future Target Date 2030 Fund 2/5/10 Company Stock Company Stock Fund JJN, Inc. Corporate Stock Fund 2/1/08 If your plan offers certain specialized investment options, such as self-directed brokerage accounts or personalized investment management accounts, this section should include descriptions of these options, including the names of advisors and brokerage companies, a description of the services offered and any associated fees or commissions. FIDUCIARY FOCUS: THE WELL-TEMPERED INVESTMENT POLICY STATEMENT PAGE 5

6 Participant education and communication This section should specify the kinds of communication and educational materials that should be made available to plan participants to help them understand and evaluate the various options. If the plan is managed to fulfill the safe harbor provisions of ERISA 404(c), this should be specified as well. Any plan claiming such compliance should state which kinds of resources the plan will use to help educate and empower participants to make their own informed investment decisions. At the very least, this section should list the following: A commitment to offering at least three investment options with varying investment strategies and risk profiles The methods (online, telephone based, etc.) participants can use to research the plan s investment options, allocate their assets among the options and make exchanges The kinds of investment materials that should be made available to help investors understand the options, including online or printed fact sheets, prospectuses, shareholder reports, fund commentaries and research provided by independent advisory services The kinds of content these materials should include, including short and long-term investment returns, benchmark comparisons, risk characteristics, major holdings and fee information Any additional retirement planning resources that should be made available to participants, including planning tools, worksheets, enrollment seminars, participant newsletters Processes for communicating changes to the portfolio as a whole or to its investment options Criteria for determining eligibility for any special features the plan may offer, such as selfdirected brokerage or personalized advice For a startup plan, this section should be finalized before investment managers are selected to ensure that the range and quality of these materials become criteria for these decisions. Even with existing plans, this section should be used as a means of evaluating the quality of materials provided by managers. Investment and IPS review processes At least once a year, the performance of the plan s portfolio and all underlying investment options should be reviewed and evaluated. The characteristics and measures to be used should be specified, and may include: Total return of the portfolio and individuals options versus their benchmarks Specific measures of risk and volatility Changes (negative and positive) in its share price over time, both at its net asset value and on a fee-adjusted basis Any changes in the employee demographics that may require adjustments to asset classes or investment options Pass/fail criteria and any tools used to evaluate these issues should be defined to keep the process as objective as possible. Possible remedial actions may also be described, such as putting underperforming or highly volatile funds on a warning list, or closing certain options to new investments. FIDUCIARY FOCUS: THE WELL-TEMPERED INVESTMENT POLICY STATEMENT PAGE 6

7 In addition, this section should outline procedures for reviewing and approving recommended changes, both to the investment options and to the IPS itself. These may include: 1. Protocols for recommending changes (written, verbal or requests or proposals) 2. Documentation to be included with recommendations (performance/risk/legal analysis, etc.) 3. Procedural guidelines for discussing, evaluating, and approving or rejecting change recommendations and documenting results You may also wish to include language specifying how often the IPS should be reviewed to determine if its provisions are still appropriate, given the current state of the market, the company, and the current regulatory environment. Reinventing the Wheel Not Required All of the steps mentioned above are merely suggestions; your company s IPS may vary in length, organization, or depth of content. And since many plan providers and ERISA-qualified investment advisors can provide sample IPS templates that you can modify to meet your plan s specific requirements, there s no need to create one from scratch. When your pension committee has finished drafting your IPS, it should be reviewed by a qualified ERISA attorney to make sure that the language conforms to ERISA standards and that it doesn t conflict with provisions in the plan document. Next Steps Once completed, distribute copies of your IPS to members of your company s pension committee, outside advisors, and plan administrators and trustees. During investment reviews, pass out copies of the IPS to everyone involved in this process so it can be used as a reference guide. If There Are Issues Even the most detailed IPS won t necessarily resolve every possible situation that could arise. For example, it s unlikely that even the most detailed IPS could have protected a plan against the kinds of losses resulting from the market meltdown of However, in the aftermath of such events, an IPS can provide a bulwark against knee-jerk reactions as long as everyone who is involved in managing the plan s investments is committed to using its guidelines as a basis for analysis, evaluating and decision-making. FIDUCIARY FOCUS: THE WELL-TEMPERED INVESTMENT POLICY STATEMENT PAGE 7

8 } Download this and other RidgeWorth White Papers at Provided compliments of This article was written by Jeffrey Briskin, President of Briskin Consulting, a marketing and creative services firm. Jeff has more than 15 years of experience working with 401(k) plan providers to deliver strategies and programs that help plan sponsors and plan participants understand and mitigate the complexities of making investment decisions. Jeff is also the author of The Briskin Consulting Study of Small Retirement Plan Sponsors, a research study that explores the reasons why plan sponsors select, stick with and switch plan providers. For more information, visit This material is provided by RidgeWorth Investments for informational and discussion purposes only. Plan sponsors and others should consult their own counsel and designated advisor, if applicable, for specific guidance on their particular circumstances. The analysis and opinions provided may not be relied upon as investment advice and may change without notice. Statements of fact are from sources considered reliable but no representation or warranty is made as to their completeness or accuracy. Unless otherwise noted, the opinions provided by the authors and other sources are not necessarily those of RidgeWorth. Information provided is general and educational in nature, provided as general guidance on the subject covered, and is not intended to be authoritative. It is not intended to be, and should not be construed as, investment, legal, estate planning, or tax advice. RidgeWorth does not provide legal, estate planning, or tax advice. Laws of a specific state or laws relevant to a particular situation or pensions in general may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. Consult with an attorney or a tax or financial advisor regarding your specific legal, tax, estate planning, or financial situation. An investor should consider the fund s investment objectives, risks, and charges and expenses carefully before investing or sending money. This and other important information about the RidgeWorth Funds can be found in the fund s prospectus. To obtain a prospectus, please call or visit Please read the prospectus carefully before investing RidgeWorth Investments. RidgeWorth Investments is the trade name for RidgeWorth Capital Management, Inc., an investment advisor registered with the SEC and the adviser to the RidgeWorth Funds. RidgeWorth Funds are distributed by RidgeWorth Distributors LLC, which is not affiliated with the adviser. Not FDIC Insured No Bank Guarantee May Lose Value RFWP-IPS-0910