Delegating Pension Plan Investment Oversight

Many pension plan sponsors are embracing a relatively new service in order to meet the fiduciary obligations of their plans. Investment outsourcing allows plan sponsors to delegate some or all of the investment management oversight functions to an investment manager who takes on this fiduciary responsibility.

Outsourcing the investment management portion of plan operations has boomed in recent years as plan sponsors look for better ways to manage costs and fiduciary liability. Until the advent of delegated fiduciary investment management, plan sponsors were on their own in implementing and following their investment policy statements, asset allocation strategies, and investment management structures to meet their contribution targets, funding levels and payout objectives.

Even with the use of investment consultants to aid in the development of the investment structure, plan sponsors were still committed to plan oversight requiring staffing resources. Although some fiduciary liability could be shifted to the consultants, the plan sponsor ultimately retained the final say and thus the ultimate fiduciary liability.

By outsourcing all of these investment management functions, plan sponsors can enjoy many benefits beyond the reduction of fiduciary liability. Outsourcing can help pension plans become more efficient by streamlining costs and enhancing asset performance. Efficiency matters as investment returns account for most of the financing for defined benefit plans and defined contribution plans.  

One study found that at least 60 percent of defined benefit plan funding comes from investment appreciation and income, with the remaining 40 percent coming from contributions. This knowledge should spur plan sponsors to look for ways of enhancing the potential for returns and managing costs.

When a plan sponsor is considering outsourcing of investment management, caution should be exercised. New strategies and investment ideas can have a negative impact and must be thoroughly vetted. As the institutional investment community has seen, new ideas such as alpha portability, hedge strategies, liability-driven investing, and risk parity can command attention and attract assets. But the performance and sustainability of a new idea often depends on market conditions.

When deciding to outsource investment management, plan sponsors should also consider what they are getting and what they are giving up in return. There are many service models available and it can be a challenge to make a direct comparison between investment management firms, or even between the services offered compared to in-house management.

Since there is no standardized reporting standard for outsourced investment management services, it can be difficult to make a direct comparison between providers. The CFA Institute has proposed a set of standards for performance guidance, but it is geared more toward investment managers. The Global Investment Performance Standard (GIPS) is currently out in draft form and seeking comment. Until the GIPS is finalized, plan sponsors must rely on information provided to them and make comparisons for themselves.

Another challenge of investment management outsourcing facing plan sponsors is having an investment strategy that is not specific to their needs. A more customized strategy can carry additional costs that must be reviewed when comparing proposals.

Plan sponsors should also consider costs and processes involved in terminating an outsourced investment manager. Aside from any potential service termination fees, they plan sponsor should consider the cost and personnel resources involved with the process of conducting a replacement search.