Risk Management

Will the 401(k) Bubble Burst?

The stock market downturn could push plans to seek a broader array of investment options.
David KatzFebruary 1, 2001

Will the downturn in the stock market be deep enough to push 401(k) plan sponsors toward offering broader arrays of investment choices to participants in the quest for better returns?

Over the last few years, that question has been irrelevant. CFOs and senior investment officers were for the most part pleased by the investment returns generated by the surging stock market.

Those robust returns put 401(k) participants in the catbird seat, both in terms of returns and proper asset allocation.

Many employers have thus had little reason to question the performance of their 401(k) providers, including the big bundlers of investment, communication, and record-keeping services, like Fidelity Investments, Vanguard Group, Putnam Investments, and T. Rowe Price, to name a few.

Such providers have helped many corporations ease their 401(k) plan workloads and worries and focus their attention on more productive areas.

During the good times, a few small 401(k) plan advisers raised their voices, complaining that such firms, by steering employees to invest in the provider’s group of funds, inherently limited the range of investments available to the employees.

Charles Schwab Retirement Services’ “open architecture” approach to 401(k) investing— throwing the door open to investment choices from a wide range of investment management firms—was seen as an example of the diversification that employees really needed.

Still, the big 401 (k) providers have already been moving in the direction of more investment flexibility for participants. In fact, Gregory D. Metzger, director of defined- benefit contribution for Watson Wyatt Worldwide in Sherman Oaks, Calif., says that the definition of “bundled” itself has changed.

A decade ago, if a company didn’t have 90 percent of its plan assets under management with a single provider, the provider wouldn’t also do administrative or communications work for the company, he adds.

Now, that percentage has shrunk to about 50 percent, and some providers are providing bundled services to employers even if the provider isn’t managing any of the plans’ investments, according to the consultant.

A big reason for the movement away from single- provider control of investments, according to Metzger, is a realization on the part of plan sponsors that “there is not a single provider that has the best investment choices in every asset class.”

Senior financial managers are now scrutinizing them more—a factor that could lead plans to greater diversity of investment offerings.

CFOs have a significant interest in achieving proper “workforce management,” which includes enabling workers to retire at the proper time, Metzger says. “An aging workforce is a more expensive workforce” he notes.

Metzger adds that a CFO is looking at “a big dollar item,” if he happens to be employed at a company that provides a 50-cent match on every employee dollar saved.

The big question on the minds of financial execs is whether the company is getting the proper value for its 401(k) expenditure, the consultant says.

But Who Really Cares?

Amid the booming returns of a financial expansion, however, who really cares about the variety of funds the returns are coming from?

In fact, a booming stock market has a way of allocating assets in a healthy manner. According to a recent benchmark study of 300 U.S. employers by Watson Wyatt Worldwide, the expanding stock market of 1999 provided close to the best of all possible worlds to participants and plan sponsors.

In 1999 almost 55 percent of the employers scored 90 percent or better in terms of an “optimal equity level”—the best possible mix of stocks and fixed income for each plan’s particular age mix, according to Watson Wyatt’s calculations. The strength of the equity markets brought more plans up to the ideal investment balance needed to provide participants with the best chance of receiving top results, according to the study.

But with the current downturn in stocks, how long will it be before participants start to achieve less comforting allocations and returns, and push for change? Certainly, senior financial executives will be keeping a close watch on the value equation.

Besides cost, the other essential part of the equation is how well the plan is serving employees’ needs. With 401(k) plans providing a bigger and bigger piece of the retirement income pie, employers must focus on how well providers are helping participants meet their retirement goals. And with the labor market still tight, companies will need to provide 401 (k) value in order to compete for talent.

Wayne H. Miller, a managing member of Independent Retirement Plan Services LLC, in Austin, Texas, a firm that helps companies run their 401(k) plans, says that since it’s so hard to distinguish among the big services providers, one of the best barometers of quality is the extent to which they match the employer’s fiduciary obligations to plan participants.

And the key measure of that is how much the provider’s aim is “to look out for the employee’s and the families’ best interest,” rather than to direct participants to funds that make the investment firm the most dollars.

Employers should beware of providers, who, “in their lust to win the business,” offer cut- rate services that end up producing poor results for employees, Miller says.

Plan sponsors should also gauge whether the provider is acting in the employer’s best interest. “There’s way too much sales function built into this game,” Miller asserts.

If the stock market continues to decline, look for more scrutiny of that sales function. And with the increasing sophistication among 401 (k) participants and plan sponsors, the big players will be struggling to justify their worth in the face of the growing push for a wider and wider range of investment choices.

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