Selecting an investment provider is one of the most important decisions that plan sponsors can make. What should be on a plan sponsor’s checklist when choosing an investment provider? We believe following the “Five C’s” Framework outlined below will increase the likelihood of positive pension plan outcomes: control, consolidation, credentials, customization, and communication.
Who will be responsible for creating the long-term investment strategy for the pension fund and who will manage the portfolio on an everyday basis? Two control categories come to mind, governance/oversight and investment management. Regardless of the investment provider chosen, the plan sponsor controls the governance and oversight of the pension plan and is responsible for setting strategic goals and objectives. The strategy can be developed with help from an investment advisor who can provide supporting analytics. On the other hand, investment management involves day-to-day execution, cashflow management, and hiring and replacing managers as needed. We see a trend in plan sponsors choosing to outsource more daily investment functions and giving the investment provider full discretion (the investment provider is responsible for making portfolio decisions). This arrangement allows the plan sponsor to focus on governance, oversight and strategy, while the discretionary investment manager implements and executes the strategy selected by the plan sponsor.
2. Consolidating Services
By using a consolidated approach, plan sponsors can potentially increase the plan’s operational and cost efficiency. From a cost standpoint, bundling investment related functions such as investment management, custody, trustee and benefit payment agents tends to cost less than purchasing standalone services — particularly when the provider is transparent about cost. From an operational standpoint, this type of arrangement would allow the investment provider to react quickly to market and cashflow needs without routing instructions to a third-party custodian. Further, by taking advantage of a consolidated approach the plan sponsor can reduce the number of providers necessary to coordinate and align the plan’s goals and objectives.
3. Credentials and Experience
Defined benefit plans and the regulations that govern them, are some of the most complex in the retirement industry. Managing a defined benefit plan is not something to be “picked up on the fly” or “learned on the job.” Prudent pension investment management involves more than just establishing a return objective. For example, a liability-centric approach requires expertise to review actuarial reports, conduct asset liability modeling, comprehend future benefit obligations, and understand regulations. Investment providers with the depth of experience needed to drive the success of defined benefits plans can improve outcomes while mitigating pension risk.
Every pension plan is unique, from the plan sponsor objectives, the liabilities structure and asset parameters. For an investment management strategy to be effective, it needs to be customized for a plan's unique circumstances. For example, pension plans typically implement a liability-hedging asset class designed to protect funded status (delivering performance that moves in line with the liabilities). Creating a liability hedge without customization is like buying a shirt without first looking at the size. Although an off the shelf bond fund can be considered liability hedging, it may not fit a pension plan’s liability and could create additional volatility. A custom strategy can add value through its ability to evolve with the plan’s liabilities and lead to better outcomes.
Financial circumstances and plan objectives can change over time. It is necessary to regularly review the plan’s strategy to see if it meets outlined objectives. Investment providers and plan sponsors who communicate proactively can make better decisions. Examples of setting good communication standards include monthly funded status reporting, regular performance reviews, and periodic formal strategy reviews.
It is important for plan sponsors to pick service providers with the necessary experience and solutions to deliver positive outcomes. The “Five C’s” Framework described in this article allows plan sponsors to determine if their current investment provider is well-suited to their defined benefit plan needs. For more information, please reach out to your PNC Representative.