In part I of this two-part report on tools that help you meet the requirements of the DOL fiduciary rule, I acknowledged that there is a high likelihood that the rule will eventually be diminished or repealed by the incoming Republican leadership in the White House, House and Senate.
But I also wondered whether this can be accomplished in less than two months, given that the rule may not be at the top of the legislative priority list. It’s probable that advisory firms will need to acknowledge their fiduciary status, justify that their rollover recommendations from 401(k) plans to IRAs were made with the client’s best interests in mind and otherwise meet the standards of the full rule for part of the year. After that, the best practice may be to continue complying – or, at least, have a way to show clients that your rollover recommendation really is superior to where they are now.
In a rare interview with Harvard Business School that was published online earlier this month, (it has since been taken down) value investor Seth Klarman spoke at length about his investment process, philosophy and the changes value investors have had to overcome during the past decade. Klarman’s hedge fund, the Boston-based Baupost has one of Read More
The first part of the report looked at the new cottage industry of DOL fiduciary compliance tools, which variously proscribed your business process for getting into compliance, comparing fees in the 401(k) portfolio with your fees and the industry standard, comparing the quality of the investments in the current and proposed portfolio, demonstrating that you’re monitoring the quality of those investments, assessing the riskiness of one portfolio versus the other and determining what trades need to be made when dialing down the riskiness to the client’s risk tolerance.
Here in part II, let’s look at a couple of new tools that give you an integrated solution to DOL fiduciary compliance. Are you recommending a superior asset allocation? Are you recommending better investments in the IRA than the client previously owned? Is the IRA’s all-in cost lower than the plan sponsor’s offering, and if not, are you offering more services than the plan sponsor was offering?
RiXtrema: Costs, performance and risk comparisons
Arguably the most comprehensive DOL rule solution available to advisors is the IRA Fiduciary Optimizer, offered by RiXtrema. Company president Daniel Satchkov thinks that there is a lot of ways for planners and advisors to add value by replacing the plans their clients are currently invested in. “According to our estimates,” he says, “401(k) plans, in aggregate, probably waste over $12 billion a year of retirees’ money.” You can find the numbers in a white paper on the RiXtrema website.
The IRA Fiduciary Optimizer is an extension of one of RiXtrema’s legacy programs, called the 401(k) Fiduciary Optimizer, used by advisors who are managing qualified assets. Among other things, the tool pulls data from the 5500 forms that qualified plans file with the Department of Labor, and looks at the underlying funds.
“You would be surprised at the data we’ve been collecting,” Satchkov says. “It’s not unusual to find plans that gouge people. I was looking at a $21 million plan this morning that didn’t bother to negotiate institutional share classes.” Pulling a plan up at random from the RiXtrema database, Satchkov finds that one of its investment options is an “A” share class from a large fund company, with an annual expense ratio of 128 basis points. “This is broad daylight robbery going on,” he mutters, considering that a lower cost, institutional share class is available for the same fund.
What to do? Pulling this and other data from the tool’s database, an advisor using the IRA Fiduciary Optimizer can assess the expense ratio of the funds the client is invested in currently within the 401(k) plan. Then it will search for superior funds – either from the advisory firm’s buy list or the entire universe of open-end mutual funds and ETFs – that have a high correlation to those existing funds.
Running the system produces several possible alternatives to the aforementioned A share fund, each with a correlation of .97 or better – a number that is not only based on the monthly behavior of the funds that are being compared, but also on the similarity of their underlying holdings, pulled from the SEC’s Edgar database using another data-collecting algorithm.
“Basically, this tells you that these funds are behaving very much like the fund they would be replacing,” says Satchkov. “In this case, I would propose to replace the position with a similar Vanguard fund, which would get almost exactly the same exposure – except that at 8 basis points a year, it is 15 times less expensive.”
After going through the process of replacing each of the fund positions the client is holding in the 401(k) plan, you can do a comparison of the costs in the 401(k) plan vs. the IRA portfolio that you’re recommending as a replacement. Most advisors will obtain the summary plan costs from statements the client provides, but if that isn’t forthcoming, RiXtrema provides access to the Larkspur Data database of 401(k) plan expenses. “Their database has 1.3 million plans in it, so the client’s plan may be included,” says Satchkov.
The system adds in the plan expenses and accounts for the fees that the advisor proposes to charge for managing the IRA. Once all the costs are on the table, the Fiduciary Optimizer tool automatically calculates – and shows in a report – that the client would reduce total all-in investment expenses from $187,000 to $60,000 a year.
The report also tracks the historical performance of each fund that has been replaced against that of the fund that the advisor is proposing, and in this particular demonstration, the difference between the lines on the graph is striking. “The lineup I am offering is not only less expensive,” says Satchkov; “it is much better performing in any type of environment that we look back at.”
By Bob Veres, read the full article here.