Magazine for Senior Financial Executives: Send in the eggheads: with employees afraid to chart their own investment strategies, some companies offer a professional management option. s

Send in the eggheads: with employees afraid to chart their own investment strategies, some companies offer a professional management option. s – Special Report 401k

Alix Nyberg

LAST WINTER, AS Magnetek Inc. CFO David Reiland was reviewing the structure of the 401(k) program at the Los Angeles-based maker of power controls, he found himself drawn to a plan that would give employees some extraordinary help with their retirement investing. Under the program, created by consultancy ProManage Inc., professional advisers actually select 401(k) investment allocations according to the needs of individual participants.

Magnetek’s old plan offered some “lifestyle” fund selections, putting groups of employees into investment strategies to meet their particular needs. But the ProManage approach sounded “much more tailored,” says Reiland, “so we thought it was a good idea.”

While most companies make some effort to educate employees on the basics of 401(k) investing, many workers fail to make choices best-suited to their situations “We have found that a good number of folks in these plans don’t have the knowledge or the desire the manage their assets,” explains ProManage CEO Carl Londe. So his company, part of a small but growing plan-management industry, seeks to design portfolios for individual members using funds in a plan, then rebalance them annually based on age, expected pension size, Social Security benefits, and current account balance. That makes more sense for participants, he says, than letting investments linger in a stable value fund, or thrusting them into the choice of the moment. Participants “like having choice,” Londe says with a laugh. “They just don’t want to exercise it.”

How have Magnetek’s 600 or so employees reacted to the availability of a managed plan, which costs each user about 0.035 percent of his or her assets annually? Nearly 80 percent have stuck with it since its inception as the company’s “default” offering last January. Reiland says that the low attrition rate, and a general lack of objection overall, are proof that it is a good approach. “I think people are happy to hand off the responsibility of managing their money to someone who is using some science to do it,” he says.

A DO-NOTHING NORM

Indeed, there is little evidence that investment education, or the availability of professional advice, prompts employees to put their 401(k)s on a sensible track. So some experts see services like ProManage sometimes making more sense than self-directed plans.

“They are a very, very viable alternative,” says Ed Ferrigno, vice president of the Chicago-based Profit Sharing/401(k) Council of America. Not that they are a popular alternative yet–97 percent of plans still leave investment choices to participants–but Ferrigno says many companies are now exploring options to relieve participants of those choices. The new approach, he says, includes adding more lifestyle funds that balance assets based on targeted retirement dates. In all of these efforts, “what we’re really looking at is a way to make a plan where good things happen if the employee does nothing.”

Doing nothing is, of course, the norm for most 401(k) investors. On any given day, the percentage of 401(k) assets transferred averages less than 1 percent of funds, according to Hewitt Associates. The only time activity has risen above 5 percent in the past five years was on September 17, 2001, following the reopening of the stock markets after the September 11 terrorist attacks. While such sluggishness may incidentally reinforce the buy-and-hold strategy recommended by many experts, unfortunately participants don’t first optimize their portfolios to produce appropriate retirement savings. So bad early decisions get compounded.

Poor savings strategies meant that “even at the height of the stock market, the average household couldn’t afford [to invest] 100 percent of what it would need for retirement,” says Economic Policy Institute economist Christian Weller. Today, employees that do rebalance are likely to aim for low-yielding, conservative funds–which are unlikely to help their households make up much of the 20 percent of total wealth lost during 2000 and 2001. That skittishness, combined with poor market performance, pushed the allocation of 401(k) assets in equities to a record low of 57.2 percent in September, according to Hewitt, down from nearly 75 percent in late 2000.

A “BIG-PICTURE CONFIDENCE PROBLEM”

Helping employees make 401(k) investment decisions has always been a tricky task because of federal Employee Retirement Income Security Act (ERISA) laws, which seek to prevent conflicts of interest by banning fiduciaries and providers from offering any advice on the plans. Valmont Industries CFO Terry McClain, for example, says he has “tried to address the big-picture confidence problem,” telling the 3,700 U.S. employees of the Omaha-based maker of poles and towers that the presence of accounting scandals at a small number of firms doesn’t mean all stocks are tainted. Still, as he sees employees move their savings to “investments they perceive to be safe, but might not be good for them long-term,” he can do little to stop them. “You have to be very, very careful,” he says.

Investment advice has been a little easier to come by lately, though, thanks to a Labor Department advisory letter last December that allows plan providers to offer advice based on third-party analyses. The ruling likely will protect plan sponsors if disgruntled employees later try to sue them for providing bad advice. And those protections could become stronger if a House-approved bill, sponsored by Rep. John Boehner (R-Ohio) were to pass Congress. (The bill would formally absolve employers from liability attached to investment advice as long as they could demonstrate a prudent selection process.)

The DoL “in effect validated our business model,” says Chris Covill, president of Annapolis, Maryland-based Scarborough Retirement Services. As a result, Scarborough is expanding its 13-year-old business of advising on and managing 401(k) assets on a retail basis into the corporate market, with several plan sponsors now joining its nearly 10,000 retail clients. Morningstar Inc. is planning to roll out a similar offering to current and new clients in first-quarter 2003. “We’ve had online advice products for a while, but the reality is they help a minority of investors,” says Mike Skinner, vice president of Morningstar Associates, a unit of Morningstar. “We see [managed plans] as a logical next step–and our customers are asking for it.” Internet-based advice provider Financial Engines is considering a similar move.

SEMINARS DON’T WORK

ProManage, which has grown to about $100 million under management from six clients in its four years of operation, says its approach is based on the premise in the ERISA legislation that plan sponsors have a responsibility for investing plan assets. Section 405d allows an employer to transfer its investment responsibilities to a professional manager, and that also applies to the assets of all employees who stay in the plan, says Londe. Employees must be able to opt out, but if they do, they effectively relieve their fiduciary of responsibility, as long as it has satisfied all the other requirements of ERISA’s Section 404c.

“It’s a ground that has not been tested, but if you have an investment team in there making well-reasoned decisions and they are made in the best interest of the participants, I don’t think they would have liability,” says Tina McKnight, general counsel for Magnetek. And CFO Reiland says the fees associated with the service were less than the lifestyle funds offered in the previous plan, putting the price in what he considered to be a reasonable range.

A benefit of these management services, vendors point out, is that they can eliminate any real or perceived conflicts of interest involving company stock ownership in a plan. Company-sponsored plans “have a fiduciary risk, even if you let people transfer in and out freely, because you can’t advise employees in any way, shape, or form to help them reduce their exposure to it,” says Covill. But a third-party investment adviser, with no bias toward or against company shares, is more likely to include them in optimal quantities.

Professional management may have a particular attraction in light of the difficulty that plan sponsors have had using education to combat investor inertia and irrationality. Generic seminars often have little impact on actual behavior, says Brigitte Madrian, an economics professor at the University of Chicago Graduate School of Business. Tracking one large company’s employees after their investment-education sessions in 2000, she found the seminars prompted little action at all. While 28 percent said in postseminar surveys that they wanted to increase their overall plan-contribution rate, only 8 percent actually did. And while nearly half walked out intending to change their allocations, only 15 percent did. “I think it’s an out-of-sight, out-of-mind phenomenon,” says Madrian.

GETTING PERSONAL

More companies, of course, are trying to personalize advice these days, using Internet-based services like Financial Engines or mPower. But for the most part, “the advice that’s out there now prominently is not one-on-one, which I think is what people are seeking,” says Bill Daniels, a senior consultant at Towers Perrin. True in-office personalized advice is expensive, notes Daniels, running about $250 to $300 more per person than the $25 to $50 annual cost of computer-generated advice.

Still, with the price of advice likely to drop as more plan providers bundle it into their offerings, some companies may want to offer both online and personal advice. “Individual advice means you can look more comprehensively at individual asset situations, like spouses’ benefits and trust funds,” Ferrigno points out.

Some companies even see it as their duty to offer advice to employees. Dow Corning, for example, paid out of its own coffers to give all employees access to an Internet-based tool from Financial Engines last year, and has managed to convince about 50 percent of them to use it. “Knowing the visibility the analysis provides into assets, I thought it would be a valuable education process, even if our employees didn’t ultimately use the advice,” says Dennis Hurley, head of Dow Corning’s pension investment and risk management.

Hallmark Cards Inc., the Kansas City, Missouri, greeting-card company, has provided employee investment advice through Financial Engines since 1999. It is looking at adding the option of managed plans, although it wants the service to mature first.

“We want to make sure that there’s a business model we like and believe in. And right now that service is so new, it’s a model we want to watch and see,” says Melanie Miller, investment manager in Hallmark’s benefits trust department. “We definitely believe there would be employee interest in those services; we just want to make sure [we choose] the right one.”

A big question, of course, is whether the investment strategies of professional management will translate into fatter retirement funds. And in that connection, so far there are few good answers. Magnetek is benchmarking ProManage’s performance against a weighted average of several indexes.

“But getting advice when the plan options are actively managed funds may not be an optimal solution,” according to Towers Perrin’s Daniels. “Many studies suggest that with or without an adviser, an active manager outperforms the index only about one out of three times.” Says CFO Reiland, “So far, ProManage has done pretty well, at least as well as what we compare it to, if not a little better. Our funds have generally suffered less than other funds in the market.”

NURTURING NEST EGGS Some companies that specialize in the management of

401(k) money for employees.

Asset-allocation

Provider Method Service History

401(k) Toolbox Age and risk Has managed 401(k)

tolerance. funds for individuals

since 1994; 65 companies

offer its service

lbbotson Assoc. Age, current salary, Has offered advice

(Through providers deferral rate, and services since 1997.

Merrill Lynch and risk profile if

Sun America) desired.

ProManage Age, pension, In business since

Social Security 1998. Has six clients

benefits, and and manages $100

current account million for participants

balance. within 401(k) plans.

No advice services.

Scarborough Goals, years to Has offered services

Retirement retirement, and risk; to individuals since

Services participants placed 1989; 10,000 customers

in one of seven use the service.

funds designed by

lbbotson Assoc.

Morningstar Age and other Has offered advice

(in trial, set for relevant criteria. services to 401(k)

introduction participants since

Q1 2003) 2000.

Provider Cost

401(k) Toolbox A percent of assets

based on account

size–annual average is

1.25%

lbbotson Assoc. Depends on

(Through providers provider.

Merrill Lynch and

Sun America)

ProManage Asset-based fee

applied only to

service users

(0.10% to 0.65%,

depending on

features).

Scarborough Flat $300 to $365

Retirement annual fee levied

Services on service users.

Morningstar Asset-based fee

(in trial, set for applied to service

introduction users only.

Q1 2003)

Source: The companies

STOCK SOLUTION When transfers are made, they are away from equities.

TRANSFER OUT TRANSFER IN

Money Market 12.3

GCI/Stable Value 44.3

Bond 37.5

Balances -9.5

Lifestyles/Premix -9.5

Large U.S. Equity -42.3

Mid U.S. Equity -3.2

Small U.S. Equity 2.3

International -2.9

Emerging Markets 1.1

Large U.S. Equity -25.5

Source: Hewitt Associates

Note: Table made from bar graph

RELATED ARTICLE: Challenging Convention

CALLING IN A PROFESSIONAL MANAGER may prevent emotions–or apathy–from dictating the allocation of employees’ nest eggs. But is it any safer to trust asset managers who use the standard theories of investing?

For Boston University professor Zvi Bodie, the answer is a resounding no. According to Bodie, all the hand-holding in the world won’t boost retirement savings, because the financial-services industry is severely biased toward equities.

Bodie recently surveyed four online advice services (Quicken, SmartMoney.com, mPower, and Financial Engines), and concluded that the educational materials and investment advice provided are “often dangerously misleading.” That’s because none offered a risk-free option, even when he plugged in data indicating he was extremely risk-averse and nearing retirement.

Even when portfolios are well diversified across equities, “stocks are not safe in the long run,” he argues in his book Worry-Free Investing, which will be released in April 2003 by Prentice Hall. As evidence, he notes that prices of put options, which hedge against a stock-price drop, tend to increase as time horizons get longer. “If stocks truly were less risky in the long run, then the cost of insuring against earning less than the risk-free rate of interest should decline over time,” says Bodie. Further, he challenges the conventional wisdom that stocks offer a hedge against inflation, noting that in the 1970s, one period of prolonged inflation, most stocks performed poorly.

In the book, Bodie and co-author Michael Clowes detail alternative retirement-saving methods, including annuities with payouts linked to inflation and college-tuition rates. Stocks are not ruled out, but are for investors “willing to accept the risk of losing some of their money.”

ALIX NYBERG (ALIXNYBERG@CFO.COM) IS A STAFF WRITER AT CFO.

COPYRIGHT 2002 CFO Publishing Corp.

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