From Selecting a 401(k) plan provider: Navigating the maze [1]
Global Finance [2], Sep [3] 2003 by Gordon Platt:
Jon C. Chambers, principal at San Francisco-based Schultz Collins Lawson Chambers, an independent investment advisory firm that offers a provider-evaluation service, says many plan sponsors make frequent changes to their service vendors.
In setting up a selection committee to evaluate plan providers, Chambers says, a company needs to include participants from a range of disciplines. The plan sponsor needs to consider which investment and service configurations best suit its needs, he says.
The most common investment structure is a menu of funds, which offers a set selection of about a dozen investment choices. Any more than that tends to be too confusing to plan participants. Other investment approaches, which are gaining in popularity, include a diversified portfolio [4] managed to meet specific risk and reward targets, and unrestricted investments selected by plan participants through a brokerage account. Fees are usually higher, however, under the self-directed approach, which is appropriate only for sophisticated investors. For many plan participants, their 401(k) holdings are their sole investment.
Once a company has decided upon the best administrative and investment structures, it is ready to begin selecting a vendor. The selection is normally accomplished through a formal request for proposals, or RFP process, whereby a cross section of service providers is asked to respond to a set of questions in a standardized format. “When we manage an RFP, we try to include one respondent from each category, such as an insurance company, a mutual fund [5] group, a bank and a securities broker,” Chambers says.
Most companies with between 1,000 and 10,000 plan participants select the bundled-service model, whereby a single vendor provides all investment, record keeping, administrative and education services, Chambers says. However, more than half of the sponsors of very large plans, those with more than 10,000 participants, choose the unbundled approach, he says. This allows the sponsor to provide services through a combination of inhouse staff and independent service providers, which allows for greater flexibility. A plan sponsor can change an investment manager, for example, but keep its other service providers. “The cheapest provider is not always the best choice,” Chambers notes.
Calling on the Experts
When it comes to measuring past performance, Chambers recommends hiring an investment consultant to conduct statistical tests. “Consider the example of two investment managers who both beat the Standard and Poor’s 500-stock index by 12% a year for the past three years,” he says. “If one manager accomplished this by being 1% better than the index every month for 36 months in a row, this manager is consistently adding value. If the second manager was up 10% one month and down 5% the next month, then up 3% and down 12%, this is not a predictable pattern.”