Disclosure and Transparency

The issue of excess has been on my mind lately, mostly focused on my fragrance collection but now expanding to the topic of investment risk management. More specifically, as I continue to lead workshops about retirement plan risk management for the Professional Risk Managers’ International Association ("PRMIA"), I am pondering whether too much of a so-called "good thing" makes sense. 

By way of background, friends and family know I am a perfume aficionado. Yes, the ubiquitous "free" gift with purchase is a plus but I do truly enjoy trying new scents. I’m not alone. According to a February 23, 2016 article on the Beauty Stat website, 2015 sales of "prestige beauty" products grew more than seven percent to $16 billion and "mass beauty" product sales climbed two percent to nearly $22 billion in the United States.

Colleagues know that I have spent several decades in the risk management industry with positions that include trading, compliance and expert testimony, depending on the year. I am the author of an entire book and dozens of articles about investment risk governance. I strongly believe in the importance of establishing an appropriate risk management protocol, following said policies and procedures and regularly reviewing whether risk management actions are effective or need to be tweaked. I likewise believe there are lots of retirement plans that should be doing much more when it comes to identifying, measuring, managing and monitoring relevant risks.

Coming back to this issue of "too much" risk management, the critical question is whether investment fiduciaries can be too cautious. Most reasonable people would likely say "yes." Regardless of plan design, if an investment portfolio is overly skewed to seemingly safe assets or funds of "safe" assets, expected return could be insufficient to meet long-term needs. A discussion about what constitutes "safe" assets is left for another day except to say that every investment has some risk. Even putting one’s money under the bed could be risky if the house burns down. Another consideration is the cost of hedging. There is no free lunch. All fees and expenses associated with risk management, including the cost of putting a good technology system in place, should be part of any risk-adjusted performance assessment.

Retirement plan fiduciaries and their advisors are well served by identifying primary goals, major obstacles and both short-term and long-term nightmares that would generate serious pain for participants. Said differently, risk management, like perfume, is a good thing unless it prevents someone from achieving important milestones. As for me, I just bought a new bottle of perfume but resisted buying the other two I wanted. This should help me with my goals of decluttering and save more money.

I was recently informed by Fiduciary News editor Chris Carosa that my blog post entitled "Effective Retirement Plan Communications" (January 8, 2017) was selected "Blog of the Week" for the second week of January. Thank you to Chris and his loyal readers. I really appreciate the recognition. It’s always terrific to get feedback about what topics are of interest to financial industry professionals.

My blog post entitled "Simplifying Retirement Planning Communications" resonated with readers. It’s no surprise that there are still discussions about how best to improve the information provided to participants. Given the amount of litigation alleging lack of transparency, sponsors are wise to offer understandable documents that can be used by employees and retirees to make financial decisions. According to "Improved Retirement Plan Communication Can Boost Confidence" (Plan Sponsor, December 15, 2016), it’s not just content but the delivery format as well. Companies are adding more retirement readiness tools to their websites, even if participants are sometimes slow to take advantage.

Financial literacy is another issue that challenges employers and participants alike. Even when adequate information is available, the recipient may be unable to digest product descriptions or performance reports. In his write-up entitled "401(k) Communication Challenges," Dr. Richard Glass bemoans the low rate of financial literacy and its negative impact on saving. His take is that defined contribution plan sponsors "have not recognized that the participants’ sense of distrust and their lack of knowledge can easily create a mindset that is conducive to inaction." He uses target date fund disclosures to exemplify his view that more should be done to put participants at ease and thereby motivate them to better prepare for life after work. His suggestions include the following:

  • Don’t sugar coat the issue of risk but instead make it known that no product is free of uncertainty;
  • Emphasize that calculations are based on assumptions;
  • Hold "educational sessions that explain to participants why arriving at the assumptions involves a lot of crystal ball gazing and why, in spite of that fact, assumptions still have to be made" for purposes of forecasting; and
  • Supply "gap analyses that show participants how many years they can expect to receive their targeted inflation-adjusted incomes at their current contribution rates."

I agree that strengthening financial literacy is essential although I am not particularly sanguine about getting everyone quickly up to speed on concepts such as diversification and risk measurement. That’s not to say that employers should look the other way. To the contrary, they should act even though some organizations will have to do more work then others. As I explain in another blog post, grade 12 proficiency in reading and math is abysmally low in the United States. Anyone who gets hired with a poor grasp of such basics may struggle with learning even elementary investing ideas. See "Employers Worry About Skills Gap That Impacts Bottom Line" (January 7, 2017).

Despite the fact that companies spent nearly $71 billion in 2015 on training, chances are those expenses will increase. Realistically, shareholders and taxpayers may have little choice but to foot the bill for further education of anyone not yet able to understand what it means to save now for later on. The Aegon Retirement Readiness Survey 2016 finds that "[A]round the world, many workers are heavily reliant on government benefits and are not saving enough to adequately fund their retirement income needs." Obviously there is no time like the present to prioritize thrift and prudent investing.

For many people, retirement planning tends to be an exercise in frustration. Some complaints focus on numbers that seek to dazzle without enlightening. Others call out language that is overly long, complex and ambiguous. The author of "HR communications falls short" (Benefits Pro, November 10, 2015) references a Davis & Company survey that validates employee angst as follows:

  • About compensation, only one out of four persons were satisfied with documents they received;
  • Regarding benefits, only fifteen percent said they were adequately apprised; and
  • Nearly ninety percent of survey-takers said they had not been provided sufficient intelligence about performance management.

These results are not good news for anyone. Shareholders are paying a company’s staff to convey important information to retain and attract talented workers. If that’s not happening, money is being wasted and that erodes enterprise value. It’s likewise problematic for active employees and retirees. Without meaningful instructions and data, they are ill-equipped to make decisions about how to save and select benefits. As a forensic economist, I’ve worked on multiple matters that addressed the frequency, magnitude and clarity of participant communications. It’s a real issue and costly when the task of communicating is done poorly.

Unfortunately, even when arguably clear and copious guidance is made available by an employer, some may resist reading and/or asking questions. As former Wall Street Journal reporter Jonathan Clements points out in "Don’t Bother Reading This" (November 18, 2016), certain persons are focused on today and not tomorrow. He adds that others "want to believe in magic" even when evidence about investment returns suggest otherwise. Finally, he bemoans the association of "sophistication with complexity." (As an aside, I don’t agree with Mr. Clements that complexity is "usually a ruse to bamboozle." However, I do acknowledge that complex economic arrangements require a thorough vetting of the risk-return tradeoff).

If my experience teaching on an investment cruise a decade ago is any indication, there are signs that financial empowerment through education is alive and well, even for those who learn on their own. Based on questions and comments I received, it was clear that the audience had a strong sense of what risks they were willing to accept and what they hoped to avoid. Admittedly, these were mostly small business owners who had grown and prospered over the years by understanding that doing one’s homework is necessary to survive.

While investment uncertainty is, by its nature, something we all face, it is always prudent to gauge risks ahead of time, to the extent possible. Employers and policy-makers who want to help others improve their financial literacy can contribute in multiple ways. Joanne Sammer advocates in HR Magazine for a "whole portfolio" focus that encompasses all savings and retirement vehicles owned by an employee and his or her spouse. See "Helping Employees Plan for Retirement" (March 1, 2014). Based on my work in the benefits world, I suggest other prescriptions to consider as follows:

  • Listen to what your constituents tell you they need to know.
  • Understand the composition of your labor force since not every demographic cohort absorbs information in the same way.
  • Become adept at storytelling to make retirement planning relatable.
  • Make it easy for employees and retirees to ask questions and receive answers in a timely fashion.
  • Get creative with snappy visuals and relevant technology tools that encourage knowledge-gathering.
  • Monitor engagement patterns and revise your communications protocol as often as needed. 

Whenever I think about getting my message out, I reflect on something a former doctoral professor shared with his students. Taking some liberties since I don’t recall his exact words, he required us to distill pages of terse text and equations into a single sound bite that a lay person could understand and care about. This drive to motivate the recipient to pay heed is undeniable. As Ryan T. Howell said in his Psychology Today article entitled "Less Is More: The Power of Simple Language" (September 20, 2012), concentrate on the problem consumers are trying to solve.

Applied to retirement planning, what’s the end goal? For millions of people, the answer is not so much about having X amount of money in the bank but more about satisfying life goals and having "enough" to make things happen.

According to a new report from Willis Towers Watson, corporations worry that employees cannot afford to leave the labor force on schedule. Fearing higher costs, many employers describe anemic retirement readiness as a "top risk" yet few monitor this on a regular basis. Researchers write "These findings suggest that sponsors have an opportunity to improve the governance of DC plans by increasing the frequency with which they monitor retirement readiness, as specific metrics on readiness would offer sponsors insight on the overall effectiveness of their plan." For a full read of this report, click to download "Unlocking Value From Effective Retirement Plan Governance."

Unfortunately, if results of a new FINRA Investor Education Foundation study reflect widespread reality, Corporate America may have an uphill and expensive battle on their hands. Nearly eighty percent of respondents self-identified as financially literate despite low scores on a quiz they took to test their knowledge. Making matters worse, financial education is a rarity. Six out of ten persons answered "No" when asked "Was financial education offered by a school or college you attended, or a workplace where you were employed?" 

Notably, the 2015 National Financial Capability Study reveals a financial literacy income gap with persons earning less money seemingly in need of greater help. If, as some predict, the U.S. Department of Labor Fiduciary Rule makes it harder for smaller investors to access financial advice, employers may need to pick up the slack. If that occurs, expect companies in search of long-term labor cost savings to incur bigger short-term cash outflows to provide employees with adequate financial education (to the extent allowed).

The takeaway is that retirement plans have a bottom line impact on shareholders. Companies offer programs to attract and retain talent but are mindful of the cost-benefit tradeoff.

In case you missed the party invitation, July 17 is World Emoji Day. There’s even a snappy anthem if you feel like dancing and singing to celebrate this annual event. A Twitter search using the hashtag #WorldEmojiDay reveals favorites by country such as the yellow sad face (US, Canada, UK), red heart (Italy, France, Japan) and blue musical notes (Argentina, Brazil, Colombia). Interestingly, these emoticons are showing up in workplace communications on a regular basis.

According to "Nine perfectly reasonable reasons to use Emoji in a business context," the use of tiny images is said to add intimacy to otherwise impersonal messages, allow readers to "infer your mood and level of humor" and enliven "boring" presentations or corporate reports. Atlantic Magazine editor Bourree Lam explains in "Why Emoji Are Suddenly Acceptable at Work" that adding the popular happy face emoji can lessen the negative impact of "toneless" text that is typically interpreted in a negative way. Business etiquette expert Jacqueline Whitmore suggests senders should err on the side of caution by avoiding anything that depicts anger or romance. Client communiques should be formal.

My take as an investment risk governance expert is to play at home and not at work. Although I have inserted a smiley face or two during my career, my view (and that of many others) is that retirement plan communications are serious transmissions. Whether documenting fiduciary, investment and operational policies and procedures or giving instructions to employees about what to consider before signing up for benefits, there is a need for precision. Major lawsuits have centered on whether disclosures are sufficiently adequate. Binding regulations require transparency. Those in charge of implementing, monitoring and revising retirement plan decisions are ill-equipped when goals, restrictions and material facts and circumstances are vague.

I can’t imagine a scenario where a happy face, pencil, bag of money or other type of cartoon clarifies versus confuses. Can you?

Being able to make an informed decision about what to buy is important and retirement products are no exception. If language is obtuse, confusing or otherwise difficult to understand, an investor may end up making an inappropriate selection or assuming too much risk.

Although each industry has its share of technical jargon, UK personal finance editor Simon Read thinks there is a "massive problem when it comes to financial services, with the pensions industry arguably the worst of the lot." In "Pension firms urged to use plain English" (Independent, March 2, 2016), he suggests that terms such as "flexi-access drawdown" or "safeguarded benefits" mean little to the everyday reader and are therefore not helpful.

In its 2014 Wall Street Journal compilation of "loathed investment jargon," American Association of Individual Investors ("AAII") executive Charles Rotblut explains "There is too often an assumption that everybody understands what is being discussed, when the reality is much different."

Naming a product for an investment strategy does not necessarily help the investor either, especially if the strategy means different things to different people or has multiple monikers. Products that are part of the smart beta family come to mind.

According to the Financial Times, their use is "swelling," with assets of around $400 billion or one fifth of the $1.7 trillion Exchange Traded Fund market. At the same time, this strategy has no singular definition or name. Ben Johnson with Morningstar describes terms such as "smart beta" and "enhanced indexes" as a "broad and rapidly growing category of benchmarks and the investment products that track them." See "A Sensible Approach to ‘Smart Beta’" (Morningstar, May 14, 2014). Eric Balchunas with Bloomberg writes that "Few can define it…"

A 2015 investor alert, issued by the Financial Industry Regulatory Authority ("FINRA"), describes a smart beta index as one that is "based on measures other than weighting by market capitalization" and gives examples of labels being used to market these products. Their recommendation is that interested persons pose six questions before purchasing as follows:

  • What is the product’s strategy?
  • What are the costs?
  • What are the potential advantages?
  • What are the potential risks?
  • How liquid is the product and its holdings?
  • Are the performance figures back-tested?

This is not a universal list of questions to ask nor is this type of risk-return inquiry unique to smart beta products. Investors and their advisors should be kicking the proverbial tires on any product being considered. Retirement plan fiduciaries need to do likewise on behalf of plan participants. The message remains the same. In order to make an informed decision, it is important that product language is clear and easy to understand.

Speaking of words, logophiles have cause to celebrate. March 4, 2016 is National Grammar Day.

I am delighted to share my recent article with readers of this pension blog. Entitled "An Economist’s Perspective of Fiduciary Monitoring of Investments" (by Dr. Susan Mangiero and published in Bloomberg BNA Pensions & Benefits Daily, May 26, 2015), I wrote this article in the aftermath of the May 18 Tibble v. Edison decision by the U.S. Supreme Court.

A central thesis is that "ongoing oversight is an exercise in risk management" and that "[r]isk management is a never ending process." The article emphasizes the importance of (a) examining multiple risk factors and not relying on performance numbers alone (b) understanding the presence of financial leverage (should it exist) (c) clarifying the role of a service provider when an outside party is used and (d) letting participants know about the type of monitoring being done by an investment committee.

The topic of this article readily lends itself to at least one lengthy book as there is a considerable amount to say. I am co-writing a sequel article with fellow economist, Dr. Lee Heavner.

If you are interested in discussing investment fiduciary monitoring as relates to trustee training, compliance or dispute resolution, please email contact@fiduciaryleadership.com.

According to survey results provided in "Pension Plan De-Risking, North America 2015" (published by Clear Path Analysis and sponsored by Prudential Retirement), "pension risk management remains a principal concern for many plan sponsors." This should come as no surprise. Low interest rates, longer lifespans and anemic funding levels are a few of the concerns cited by the fifty-one senior professionals who answered questions. Half of the respondents agree that implementing a risk management strategy sooner than later makes sense, with one out of four individuals indicating an intent to transfer risk to an outside insurance company in 2015. Three out of four survey-takers "believe that movement in interest rates will impact their decisions to implement a liability driven investment strategy, or to execute a bulk annuity transaction." When asked about the use of alternatives such as hedge funds, fourteen percent replied that they currently use and seek to increase. One third currently allocates to alternatives and two percent look to introduce. Assuming that a respondent can only answer this question once and that there is one survey-taker per pension fund, this means that there is roughly a fifty-fifty split when it comes to including alternatives as part of a defined benefit plan investment portfolio.

If true that lower interest rates may discourage some plan sponsors from fully transferring risk to a third party insurer via a buy-out but they nevertheless seek to more actively manage pension risks, one could logically expect a greater use of a strategy such as Liability-Driven Investing ("LDI"). To the extent that LDI frequently entails the use of derivatives, those plan sponsors in favor of LDI may want to take note of a recent move by the U.S. Securities and Exchange Commission ("SEC"). As I just posted to my investment risk governance blog, certain registered funds could soon be asked to publish a considerable bounty of data about how they price securities, characteristics of trading counterparties and the specific use of derivative instruments. See "SEC and Asset Manager Disclosures About Use of Derivatives" (May 21, 2015). Sometimes an LDI strategy can include an allocation to alternatives. Post Dodd-Frank, lots of alternative fund managers are registering with the SEC. Connecting the dots, plan sponsors that use LDI and/or invest in alternatives are likely to benefit from enhanced disclosures made by asset managers.

Even those sponsors that decide on a risk transfer of some type other than LDI will soon be impacted by reporting mandates. In "Employers must disclose pension de-risking efforts to PBGC," Business Insurance contributor Jerry Geisel explains that data regarding lump sump arrangements will have to include answers to questions such as those listed below:

  • How many plan participants "not in pay status" were offered a chance to switch from a monthly annuity to the lump sum payout?
  • How many plan participants "in pay status" were given a choice?
  • What was the number of participants who made the choice to take a lump sum?

In its filing with the Office of Management and Budget ("OMB"), the Pension Benefit Guaranty Corporation ("PBGC") writes that "de-risking" or "risk transfer" events "deserve PBGC’s attention because (among other things) they lower the participant count and thus reduce the flat-rate premium and potentially the variable rate premium." Fewer dollars being paid for this last-resort insurance "have the potential to degrade PBGC’s ability to carry out its mandate…"

Given the complexities of managing pension risks and the regulatory changes underway, you may want to attend the May 27, 2015 educational webinar entitled "Pension De-Risking for Employee Benefit Sponsors: Avoiding Litigation and Enforcement Action." I hope you can join us for a lively and topical event.

Seeking to accomplish a goal without having the right tools can result in frustration and possible failure. One solution is to get outside help when needed as long as the party being hired is knowledgeable and independent. Otherwise, what looks like a solution could quickly become a problem. Applied to ERISA plans, trouble might take the form of costly and time-consuming enforcement and/or litigation. Over the last few years, that reality has set in for more than a few employers.

Recognizing the importance of abiding by good governance principles, several of us agreed to speak as part of an educational webinar on April 8, 2015 about fiduciary tools, pitfalls and lessons learned. Sponsored by fi360 and entitled "ERISA Litigation and Enforcement: The Role of the Independent Fiduciary and Best Practices for Financial Advisors," this webinar joined Attorney Tom Clark (Counsel with the Wagner Law Group), Dr. Susan Mangiero (Managing Director with Fiduciary Leadership, LLC) and Mitchell Shames, Esquire (Partner with the Harrison Fiduciary Group) to address the (a) use of an independent fiduciary (b) clarifying what an outside vendor should be doing and (c) avoiding legal and economic landmines that have revealed themselves in prominent court cases and regulatory examinations.

If you missed the event, email contact@fiduciaryleadership.com for a copy of the slides. Click here to download the written transcript. Edited for clarity (and because the audio file is spotty in some places), this fourteen page document lays out cornerstone concepts and includes suggestions for plan sponsors and the advisers who serve them. These include, but are not limited to, the following:

  • The outsourced fiduciary market is growing in the United States and elsewhere.
  • When an outside party is hired by a plan sponsor, it is critical to specify responsibilities and contract accordingly. When an "expectations gap" exists, some critical tasks may be left wanting or not addressed at all.
  • When multiple fiduciaries are in place, a plan sponsor must ensure that a central person or team is adequately coordinating the efforts of all fiduciaries.
  • The newly proposed Conflict of Interest rule is predicted to materially change the landscape of fiduciary relationships between plan participants and retirement advisers.
  • A fiduciary status may exist due to either a contractual agreement or by virtue of the functions assumed by an individual or organization.
  • ERISA litigation is getting more attention these days, with a particular focus on fees, use of proprietary funds, revenue-sharing and disclosure of compensation paid to investment consultants, advisers and asset managers.
  • Demonstrating procedural prudence in part depends on what others in the industry are doing (or not doing as the case may be) and whether actions make sense for a given plan.
  • A renewed focus on disclosure and transparency is in the works according to comments made by the U.S. Department of Labor.
  • An independent fiduciary can be engaged for a singular transaction or for a task that continues over a long period of time.
  • An independent fiduciary can be engaged by either a defined contribution plan or defined benefit plan or both.
  • When there is a perception or reality of a conflict of interest, it may be prudent for an independent fiduciary to be engaged. The participants pay for said party because the independent fiduciary works on behalf of the participants.
  • The concept of co-fiduciary status is important and should be paid heed by any adviser who has an ERISA plan as a client.
  • Before delegating duties (to the extent allowed) to a third party, a plan sponsor should decide what financial issues should be vetted. Liquidity, the use of leverage by asset managers and asset allocation are a few of the many topics that a delegated fiduciary could be asked to measure, monitor and manage.
  • A fiduciary audit can be extremely helpful as a tool for identifying areas of improvement for an ERISA plan sponsor.

It may be no surprise that over 500 people registered for this educational webinar about fiduciary foibles. After forty years since its inception, ERISA remains a force that cannot be ignored.