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Best practices for fund replacements to keep you in compliance

Posted by Dave Palascak, Vice President, Product Management on March 23, 2018 in Fiduciary Excellence

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When replacing a poorly performing investment in a fiduciary account, follow these best practices to ensure fiduciary compliance.

We will use a 401(k) plan in our review below, but these best practices apply for any fiduciary account such as an IRA, Defined Benefit Plan, Trust account, Foundation/Endowment and many others.

Document why the investment is being replaced

Before the replacement process even starts, you should consult the plan’s Investment Policy Statement (IPS) and review how the investment stacks up against the watch list parameters.  How severe are the shortfalls?  How long have they persisted?  Document this analysis in your plan monitoring reviews.

Don’t have an IPS?  Get one ASAP! The IPS is the blueprint which ensures proper management of the plan.  Without one, you will have a much harder time documenting and justifying why changes are or are not being made.(Practices 2.6, 3.3 and 4.1)

Identify a short list of investments that merit further research

Your IPS should contain the search criteria that are used to identify potential investments for the plan.  These criteria are typically the same as the watch list criteria but depending on the platform you are using and the asset class you are looking for, you may need to refine this further to arrive at a manageable set of results.  

Many advisors use the Fi360 Fiduciary Score® as a starting point for their criteria, but any documented and prudent set of criteria that include elements such as expenses, performance, risk, composition, style and operations will do.  The key is that you have a documented, repeatable and prudent process that you can justify if it were ever to be called into question in a court of law.

Once you have applied your search criteria, you will typically want to have a short list of investments (5-15) that merit further quantitative or qualitative review.  So, if needed, tighten your search criteria to get your results down to a more manageable list.

Cut the short list down to the finalists

At this stage, you are conducting a more detailed analysis of the investments on the short list.  This may be done via Investment Factsheets, Investment Comparisons or qualitative research such as analyst reviews or direct conversations with the investment managers.  Document this analysis and use it to cut your short list down to the finalists.  

If you’re serving in a 3(38) discretionary role, you will take this all the way down to the investment to be used.  If you’re in a 3(21) role, we recommend including two to four alternatives in your plan monitoring review so that you can discuss the options with the investment committee or other authorized individual(s) who will make the final decision.

Make the replacement; and do it across all your plans!

In many cases, the investment being replaced will exist in more than one plan.  We recommend applying this research and resulting recommendations to any plan that holds the investment.  If you’re in a 3(38) role, this is more straightforward as you have discretion to enforce the change.  If you’re in a 3(21) role, the committee retains the discretion on the investment to select and the timing for the replacement, but it will make your practice far more efficient if you can get them to agree on a consistent course of action.  

If you’re using a variety of different recordkeepers with different available investments, this can make the process a little more difficult to streamline as you will either need to ensure all your possible replacements are available on each recordkeeper or have different replacement scenarios for different recordkeepers.  For this reason, among many others, the more you can reasonably limit your recordkeepers, the more efficient and consistent your practice can be.

Rinse and repeat

Now that the investment has been replaced, the process starts all over again.  Continue to monitor the investments quarterly against your IPS and follow the steps above when considering any replacement.  Like good design, people know a good fiduciary process when they see it. Stick to the plan and you will be sure to succeed. 


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