Retirement and Investment Solutions Newsletter
October 2010 Issue
Participant Communications News:
- International Funds – Potential, Positioning and Performance
- Decoding Target Date Fund Design – Rebalancing
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Availability of products and services featured in Insights vary by plan. For details, contact your J.P. Morgan representative.
Legislative and Regulatory Outlook
Fourth Quarter Predictions and 2011 Impact
While things may be quiet for pension reform from a legislative standpoint, we would expect to see much more activity from a regulatory standpoint. Earlier this year, we saw the Department of Labor (DOL) release final interim regulations on fee disclosures from plan providers to plan sponsors. On October 21, 2010, the DOL released proposed regulations to revisit the definition of who and what constitutes a fiduciary for purposes of offering investment advice. The DOL has expanded the definition to include parties that work with plan sponsors in designing and monitoring investment menus. Another regulatory proposal from the DOL is currently with the Office of Management and Budget for review and should be released later this year. The DOL will also be reopening the qualified default investment alternative (QDIA) regulations. The focus here will be on what additional disclosures may be needed when a target date fund is selected as a QDIA.
Regulatory activity should heat up
While things may be quiet for pension reform from a legislative standpoint, we would expect to see much more activity from a regulatory standpoint. Earlier this year, we saw the Department of Labor (DOL) release final interim regulations on fee disclosures from plan providers to plan sponsors. A number of regulatory proposals from the DOL are currently with the Office of Management and Budget for review and should be released later this year. Initiatives include revisiting the definition of who and what constitutes a fiduciary for purposes of offering investment advice. The DOL is interested in expanding the definition to include parties that work with plan sponsors in designing and monitoring investment menus. The DOL will also be reopening the qualified default investment alternative (QDIA) regulations. The focus here will be on what additional disclosures may be needed when a target date fund is selected as a QDIA.
Fee disclosure guidance issued
On October 14, the DOL issued final regulations on the fee disclosures that plans must provide to participants. The regulations are applicable for plan years beginning on or after November 1, 2011 (January 1, 2012, for calendar year plans). The regulations require disclosure in four broad areas:
Disclosure of general plan information – how to make investment elections, disclosure of any restrictions.
Disclosure of any general expenses – e.g., recordkeeping expenses charged directly to the participant’s account. These expenses would also need to be shown on participant statements at least quarterly.
Participant-specific expenses – charges incurred for participant-initiated transactions, such as loans or qualified domestic relations order (QDRO) processing. Once again, these expenses would need to be shown quarterly.
Investment-related expenses – The proposed regulations would require an investment comparison chart that shows all designated investment options available under the plan, compares historical performance, expense ratios and any loads or redemption fees, comparisons to benchmarks and examples of what expense ratio expressed as a dollar amount on a $1,000 investment.
The final category – the investment comparison chart – will probably be where we see the most differences from the proposed regulation. We would also expect to see an effective date on the final regulations at least one year out.
An analysis of these regulations may be found on our Instant Insights - Legislative and Regulatory News page.
Impact of Small Business Jobs Act
The Department of the Treasury will also have its hands full interpreting the provisions in the recently signed Small Business Jobs Act that will allow, should the plan elect, participants eligible to receive a distribution to roll that distribution into a Roth source within their plan. Given that these provisions became immediately effective, we are hopeful that Treasury will give us some guidance – even if it is informal – sooner rather than later.
Retirement income hearing
Finally, both the DOL and Treasury held a joint hearing on lifetime retirement income. J.P. Morgan Retirement Plan Services testified at that hearing. (View head of product organization Donn Hess’ testimony below, or download PDF transcript). Issues discussed include how to encourage participants to consider annuitizing a portion of their distribution and what guidance/safe harbors they might provide plan sponsors to increase their comfort with offering annuities. They also focused on disclosure of account balances as an income stream at retirement, similar to the legislative proposal. A great deal of testimony focused on how these disclosures should be calculated and expressed. We would expect to see the DOL and Treasury consider regulations in these areas next year.
Of course, any predictions of legislative and regulatory agendas are only as good as the facts available at the time they are made. Political or economic events could change priorities. In any event, we will continue to monitor these events and keep you up to date.
Q & A From Third-quarter Legislative Update
Our quarterly Webcasts on legislative and technical topics, hosted by Bob Holcomb, head of legislative affairs, continue to be popular with plan sponsors and consultants. These are some of the questions and answers from our most recent Webcast on August 4.
Question 1: How do these disclosure requirements pertain to clients with advisory services, such as online advice or managed accounts?
Answer 1: Two of the key questions in determining whether a plan service provider has a disclosure requirement are:
Does the service provider fall within the definition of covered service provider?
How is it compensated?
The Interim Final Regulations define covered service provider in three broad categories:
Fiduciaries (including registered investment advisors): If the party providing advisory services is a registered investment advisor providing direct investment advice services to the plan, it would have a reporting requirement and must report its compensation whether that compensation is direct (paid directly by the plan) or indirect.
Recordkeepers and brokers providing an investment platform to individual account plans.
Service providers to the plan receiving indirect compensation: Investment advisors could also fall into this category.
In fact, the regulations provide a list of services covered in that definition, which includes investment advisory services for either the plan or the participants. But in order to have a reporting requirement under this category, it would have to be receiving indirect compensation, which is defined as compensation received from some party other than the plan, the plan sponsor or another covered service provider.
Another possible way a service provider may have a disclosure requirement is if its compensation is required to be reported by another covered service provider. The regulations place an additional requirement on covered service providers to disclose compensation paid to affiliates or subcontractors if that compensation is transaction based (e.g., commissions) or charged directly against a plan investment and reflected in the net asset value (e.g., 12b-1 fees).
While advisory services could fall under one or more of the definitions of covered service provider, we must look to how the investment advisor receives its compensation to determine its reporting requirement.
Question 2: Are all disclosures passed through the recordkeeper, or do some providers report directly to the sponsor?
Answer 2: To answer this question, we need to go through an analysis similar to the first question. As a covered service provider, a recordkeeper must disclose all direct and indirect compensation received. Direct compensation would include payments directly from plan assets while indirect compensation would cover any compensation received from a source other than the plan, the plan sponsor or another covered service provider. In addition, the recordkeeper as a covered service provider has an additional requirement to report compensation paid among related parties, which would include affiliates and subcontractors. As mentioned previously, this compensation is reportable if it is transaction based (e.g., commissions) or charged directly against a plan investment and reflected in the net asset value (e.g., 12b1 fees).
There is an additional requirement placed on recordkeepers to report expenses related to designated investments of the plan (self-directed brokerage windows are not covered under this requirement). The expenses that must be disclosed include direct charges (e.g., sales loads, redemption fees), expense ratios and any other ongoing expense.
There may be other service providers to the plan, such as trustees or registered investment advisors, who are receiving direct or indirect compensation. They would have their own reporting requirement separate from the plan’s recordkeeper.
Question 3: Do the fee disclosures need to be mailed, or can they be sent electronically?
Answer 3: There does not appear to be any prohibition of electronic disclosure, and, in fact, in its analysis of the cost of complying with the regulations, the Department of Labor anticipates that 50% of the disclosures will be sent electronically.
Question 4: Did you really say a government entity wants a disclosure stating a target date fund should not be selected based on date of birth and target retirement date alone? How else would a participant select a target date fund?
Answer 4: The Securities and Exchange Commission (SEC) has proposed amendments to rule 482 under the Securities Act of 1933 and rule 34b-1 under the Investment Company Act of 1940 that would modify requirements and statements made in advertisements and supplemental sales literature related to target date funds. One such modification would be the necessity to include a statement to the effect that there are other factors, in addition to age or retirement date, that should be considered when selecting a target date fund. Such other factors would include the investor’s risk tolerance, personal circumstances and financial situation.
In reviewing marketing materials for target date funds, the SEC noted these materials often characterize target date funds as offering a simple solution for retirement needs, such as choosing the fund which has a target date that most closely matches the individual’s target retirement date. Part of the confusion related to target date funds, from an investor’s perspective, has been the construction of the glide path (i.e., the change in asset allocation over time). The asset allocation could become fixed sometime after the fund’s target date. The SEC rules refer to this point in time as the landing point. Thus, investors would be encouraged to understand when the landing point occurs (which also equates to the time when the asset allocation is most conservative, in terms of the mix of equities relative to fixed-income investments), and choose a fund that matches the individual’s circumstances and risk tolerance.
Question 5: How does the current Value Benchmark that J.P. Morgan provides plan sponsors comply with plan sponsor disclosure requirements?
Answer 5: Our Value Benchmark provides much of the information required under the Interim Final Regulations, but there will be additional disclosures required. We will be analyzing the various requirements and designing our disclosure notices in a manner that provides the information in a clear and understandable fashion.
Question 6: Are fund managers service providers for indirect and direct compensation disclosure (fund managers included in a defined benefit pension portfolio)?
Answer 6: Disclosure information is only required of “covered service providers,” of which there are three categories:
a. direct fiduciaries to the plan
b. fiduciaries to plan asset vehicles
c. registered investment advisers
recordkeepers and brokerage service providers that offer a platform of investments to participant-directed individual account plans, such as 401(k) plans
other indirectly paid service providers
For both defined benefit and defined contribution plans, if the investment manager is providing services as a direct fiduciary to the plan or as a registered investment adviser, it is a covered service provider subject to the fee disclosure requirements. Determining fiduciaries to plan asset vehicles under category 1.b. is not as clear cut. This category includes investment managers who provide fiduciary services to an investment contract, product or entity that is considered to hold plan assets and in which the plan holds a direct equity investment. This means the answer really depends on the type of fund arrangement.
For example, mutual funds are not considered to be plan assets under the Employee Retirement Income Security Act of 1974 (ERISA). Thus, investment managers to mutual funds in which a plan invests are not covered service providers. On the other hand, a collective trust fund maintained by a bank or a pooled separate account maintained by an insurance company* are considered to hold plan assets. Fund managers of these arrangements would be covered service providers subject to the disclosure rules.
*There is an exception for a pooled separate account which is maintained in connection with a fixed income contract of the insurance company, such as a GIC.
Question 7: What's the difference between the new fee disclosure regulations and what is already going to be required on the 2009 Schedule C?
Answer 7: The new fee disclosure regulations under §408(b)(2) of the tax code will require that a service provider furnish information relative to its fees and services to a plan prior to the time a contract or arrangement is entered into. This will ensure that plan fiduciaries have the necessary information to determine if the fees relative to the services are reasonable. Schedule C of Form 5500 also reports service provider fees, but this information is provided after the end of each given plan year. While this information also provides plan fiduciaries an opportunity to examine fees, Schedule C information can only be reviewed after the fact, as the 5500 Form is due seven months after the end of the plan year, assuming no extension applies.
Ideally, the IRC §408(b)(2) regulations would have been issued first, but due to the electronic filing requirements of Form 5500 (EFAST2) that went into effect for the 2009 plan year, the Schedule C requirements were issued first. In some cases, such as for eligible indirect compensation (certain fee reimbursement arrangements that are charged to investment funds and reflected in the value of the investment), Schedule C provides no detailed information – only that such amounts exist. This is due to the requirement that more specific information has to be disclosed prior to the initial contract or arrangement or within 60 days after a change thereto.
Participant Communications News:
Audience of OneSM Wins Awards
We know the power of our Audience of One-crafted participant communications, but it's great to be recognized by third parties. In late September, we won seven awards from the Profit Sharing Council of America (PSCA) and several Silver Quill awards from the International Association of Business Communicators (IABC), Southern Region division. The Way Forward, the online communication program that helps participants know what they can do to live comfortably through retirement, was awarded two Silver Quills for communications management and electronic/digital communication.
PSCA's annual Signature Awards is a competition designed to honor excellence in plan communication and investment education. It also provides plan sponsors with external, objective recognition of the efforts of their company and their staff. The IABC Silver Quill awards competition showcases excellent work of its professional association’s members. Judges from across the country evaluate entries on strategy, effectiveness and creativity.
New newsletter includes tips to retire on track
It’s easy for participants to find tips to retire on track and more – with just a quick click through our new electronic newsletter. This guide to our award-winning, online education series, The Way Forward, is organized by topic and helps employees easily reach articles, recordings, videos, etc. The Web site can help rebuild and revive participants’ retirement accounts, while promoting the company’s retirement plan benefit.
International Funds – Potential, Positioning and Performance
On the heels of the strong market rebound in 2009, investors have been presented with a very volatile and choppy market in 2010. Many have been trying to figure out where the best opportunities are going forward. One idea that looks attractive, for a number of reasons, is international funds.
Let’s explore a few reasons international funds may be a good option to consider. Coming out of the recession and into the recovery, we have seen many “Euro-Zone” countries start to emerge from the downturn. While their recovery has been slower than that of the U.S., their stocks have actually outperformed those in the U.S. domestic markets. Why have their stocks performed better?
Emerging markets entry point
One reason is European companies have made much larger direct investments into foreign companies. This is important because these foreign companies are providing an entry point to many of the emerging market countries, and the growth rates there are much higher than those you find in the developed countries.
The average European company generates 23% of its revenues from emerging market countries. These countries present unique investment opportunities and are poised for growth going forward. The urbanization of these countries will provide a great opportunity, as an estimated 350 million people are expected to move to urban areas over the next five years. The demographics of these areas will change dramatically and provide many customers with a variety of companies. The emerging markets countries are already starting to grow rapidly again, and these favorable trends should do nothing to stop that.
Japan’s impact on international funds
Emerging markets exposure is a trend that is not limited to just European companies – many of the emerging markets are located in Asia, and Japanese companies are benefitting from this trend, just like their European counterparts. Japan actually exports more to Asia than it does to the U.S. and Europe combined. As these countries “emerge,” Japanese companies are positioned to grow with them.
As you can see, there are some interesting opportunities across the globe of which many companies are positioning themselves to take advantage. Many of these companies are located outside the U.S. If you don’t offer an international fund in your retirement program, now may be a good time to take a look at one. And if you do have one, is it invested to take advantage of these trends? For more information, contact your J.P. Morgan relationship manager.
Decoding Target Date Fund Design – Rebalancing
This article is the sixth in a series. Last month's article was Decoding Target Date Fund Design – Portfolio Construction.
What is your portfolio’s rebalancing strategy?
As markets move over time, multi-asset class portfolios, such as target date funds, drift from their original asset allocation strategies. Periodic rebalancing helps maintain the portfolios’ targeted risk/reward profiles. While this concept seems relatively straightforward, executing can vary widely and may be shaped by factors such as whether a manager is a single provider, open architecture fund or customized solution. Decision makers should consider how different approaches to rebalancing, cash flow management and tactical asset allocation can affect a portfolio’s ability to achieve its long-term goals.
Questions to consider:
How does the manager approach rebalancing?
Different rebalancing strategies largely hinge on two critical decisions: When to rebalance and by how much. How the manager addresses each point will largely determine the portfolio’s tracking error to its strategic allocation.
How are cash flows managed?
Cash flows offer an additional rebalancing opportunity and can help or hinder a portfolio’s tracking error. The manager must consider how cash flows affect overall portfolio allocations, as well as underlying strategies.
Answering these questions can help you begin to compare different rebalancing strategies and decide which approach makes the most sense for your particular needs.
TARGET DATE FUNDS. Target date funds are funds with the target date being the approximate date when investors plan to start withdrawing their money. Generally, the asset allocation of each fund will change on an annual basis with the asset allocation becoming more conservative as the fund nears the target retirement date. The principal value of the fund(s) is not guaranteed at any time, including at the target date.
For questions about your personal retirement plan, contact J.P. Morgan Retirement Plan Services at 800-345-2345 or call your retirement plan provider.
Availability of products and services featured in Insights vary by plan. For details, contact your J.P. Morgan representative.
This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for investment, accounting, legal or tax advice.
Certain underlying Funds of the Target Date Funds may have unique risks associated with investments in foreign/emerging market securities, and/or fixed income instruments. International investing involves increased risk and volatility due to currency exchange rate changes, political, social or economic instability, and accounting or other financial standards differences. Fixed income securities generally decline in price when interest rates rise. Real estate funds may be subject to a higher degree of market risk because of concentration in a specific industry, sector or geographical sector, including but not limited to, declines in the value of real estate, risk related to general and economic conditions, changes in the value of the underlying property owned by the trust and defaults by the borrower. The fund may invest in futures contracts and other derivatives. This may make the Fund more volatile. The gross expense ratio of the fund includes the estimated fees and expenses of the underlying funds. A fund of funds is normally best suited for long-term investors.
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