A four-step approach to help meet participant needs

Have you ever been to the grocery store to pick up a basic item, such as a jar of jelly, and, faced with too many different types to choose from, became thoroughly confused and walked away without picking any of the

Jeff Elvander, CIO of Aliso Viejo, Calif.-based 401(k) Advisors, believes sponsors can learn a lot from the jelly example. In fact, he thinks that same level of inertia can occur with plan participants faced with too many investment choices.

"On some level, offering many choices to people can help elevate interest and excitement," he says. "But, based on the principles of behavioral finance, we know that presenting too many choices can actually confuse participants. By simplifying investment menus, we can help eliminate that confusion, and help unsophisticated participants who are not sure how to select diversified portfolios."

Menu simplification or modification can be an important way for advisors to promote their value—once they understand the impact of what they can bring to the table.

"Advisors need to start wrapping their head around the notion that menu simplification can actually increase their value."
- Michael Coelho, Managing Director, SageView Advisory Group

"Advisors need to start wrapping their head around the notion that menu simplification can actually increase their value," says Michael Coelho, Managing Director of SageView Advisory Group in Austin, Texas. "When we simplify or modify lineups for our clients, our role becomes much more critical because we then need to constantly assess the performance of managers (and replace them, if necessary) to ensure that investments are performing in the way we expect them to."

Here is how DC advisors Michael Coelho and Jeff Elvander approach menu simplification with their clients:

1. A la carte or pre-fix? As participants' confidence level with 401(k) investing has evolved, so has menu design. DC plans have seen an evolution to three tiers: the "do it for me" tier, which is a target-date fund or other QDIA option; the "do it with me" tier, consisting of core funds; and the "do it myself" tier, representing self-directed brokerage accounts (SDBAs) that provide participants with multiple investments. Grouping investment choices can make selection less overwhelming for plan sponsors and participants.

Both Coelho and Elvander are hesitant to pin down the exact ideal number of menu options that may be appropriate for DC plans, since much of that can depend on plan demographics and behavior patterns. On average, DC plan sponsors include approximately 20 investment options from three to five separate investment managers within their plan investment lineup1. While the majority left their plan investment options untouched over the past year, plan sponsors anticipate more activity in the upcoming 12 months.

As a guideline, they say it's important to try to strike a careful balance between choice and having too many choices. For example, plan sponsors who want to appeal to the "do it for me" tier with target date funds but also maintain an element of choice for the do-it-yourselfers, Coelho suggests adding a SDBA to menus as a way to keep the menu simple but flexible to more participants.

"By simplifying investment menus, we can help unsophisticated participants who are not sure how to select diversified portfolios."
- Jeff Elvander, CIO, 401(k) Advisors

2. Don't "box" yourself in. When simplifying core menus, Coelho suggests moving away from the traditional style boxes and considering broader core style mandates such as passive and active to achieve greater diversification across the risk spectrum. "Many plans are overweight U.S. equities and although these investments can represent different styles, they may be highly correlated to one another and can offer a poor level of diversification," he explains.

3. Find "skillful" multi-managers. Single managers can quickly go out of favor or leave organizations. That's why many sponsors prefer a multi-manager structure, which can offer exposure to a range of styles and offer greater diversification for participants. Elvander recommends looking beyond performance to find "skillful" managers in both asset allocation and security selection.

"It's pretty easy to identify the hottest or the best performing manager when you've got one metric--performance. But it's important to look at both qualitative and quantitative aspects such as philosophies, styles, and approaches," he explains.

Elvander adds that many plan sponsors make the mistake of grouping all managers of different investment styles together in one category—such as active and passive—and then evaluating them according to their peer group ranking or whether they are in the top decile. "That's like looking at returns only," he says. "If managers have different philosophies, it means you need to look at them differently."

He also believes it's important to establish a broadly-defined benchmark, while allowing managers to demonstrate their skill in areas that may not be their core strategy, but in areas where they can add value where appropriate, such as global real estate, emerging markets, or Treasury Inflation-Protected Securities. These types of investments can be grouped together and provide broader diversification without "crowding" the menus.

4. Customize, when appropriate. Target date funds are becoming a predominant element of DC plans. But just as core menus are evolving to include a multi-manager approach, Coelho believes more plans will migrate from a single provider to a custom, multi-manager approach to address the needs of a more diverse demographic.

His team recently worked with an insurance provider to not only implement auto features and a reenrollment, but also to create a custom target date solution. Initially, the plan sponsor was concerned about having participants default into a custom solution—but participants responded enthusiastically.

"They appreciated the thought that went behind the design—they even thanked us after the participant meeting," says Coelho. "They saw the value in having a best-in-class offering utilizing best-in-class managers. As a result, both plan participation and satisfaction has increased. From the plan sponsor's view, they are happy they don't have to avoid the investment discussion—like they did in the past—and have now become more engaged about the well-being of their participants."

Coelho adds that custom target date options are just one of many options and features plan sponsors should consider when evaluating menus. "Ultimately, to really move the needle and improve menu design and outcomes, we need to consider everything—reenrollment, auto features, streamlined menu design, custom target date funds, and more," he says. "All of these features and options are important parts of the stew. There is no one silver bullet."

Sponsors Eye More Menu Changes

Over half of plan sponsors say they either will expand, reduce or modify their investment line-ups this year, up from 44% of plan sponsors that anticipated changes one year ago, according to the DC Investment Manager Brandscape report.2

What's driving the change? Underperformance relative to benchmarks, in addition to fees, consolidation of investment managers and poor communication with providers.

Many plan to incorporate investment options from about three to five investment managers on their platforms. Only 51% rated their investment managers as an 8, 9 or 10 on a 10-point scale, indicating many are not very satisfied with their investment relationships.3

1 DC Investment Manager Brandscape™, June 2013, Cogent Research

2 ibid

3 ibid

Investment strategies such as diversification do not ensure a profit and cannot protect against losses in a falling market.

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