PPA supports new business models

Investment advisers can thank the 2006 Pension Protection Act for giving them a new opportunity. Advisers can now create business models aimed at the $17 trillion that baby boomers will manage over the next two decades as they work toward retirement. By way of background, Louis S. Harvey of Dalbar Inc., the Boston-based research and ratings firm, and I began comparing notes in July about our individual interpretations of the opportunities afforded by the new law. We quickly discovered that each had a different view, because of the different perspectives we had in assessing the PPA. Lou looked at the role a retail adviser could play with plan participants; I looked at the act through the lens of the investment adviser whose client is the plan sponsor. We identified two basic business models that an adviser can use to generate revenue from 401(k) plans: Model No. 1: The plan-level investment adviser is a fiduciary who provides consulting services to the plan sponsor and the investment committee. In Employee Retirement Income Security Act parlance, the adviser is an "investment fiduciary" who will not be able to turn a blind eye to the fiduciary shortfalls and omissions of the plan sponsor. Model No. 2: The retail investment adviser who provides specific investment advice to plan participants serves as a "fiduciary adviser," a term that was introduced by the PPA. The "fiduciary adviser" has the more limited responsibility for advising participants. The model choice need not be either/or. Most investment advisers will want to offer both — personally or through an associate or an arrangement with another adviser. Some broker-dealers, however, are limiting advisers to one role. One thing on which Lou and I absolutely agree is that there are different skill sets and knowledge required to master both models. I hope not to diminish the objectivity of this column, but the training historically provided by my firm, Fiduciary360, as well as that provided by the Arlington, Va.-based American Society of Pension Professionals and Actuaries, the Greenwood Village, Colo.-based Investment Management Consultants Association and PlanSponsor Institute of Stamford, Conn., would help support Model No. 1, whereas the training offered by Dalbar is best-suited to support Model No. 2. Here are some derivative models to consider: Specializing in the evaluation, selection and monitoring of qualified default investment alternatives. The QDIA represents one of the most important investment options made available by plan sponsors. But it is an option that is too complex for the typical plan sponsor to select and monitor on its own. This is an area ripe for specialization. Constructing participant portfolios to use as a QDIA. (I don't want to use the word "model" to modify portfolio because it prompts a different discussion under the PPA.) The investment adviser can construct participant portfolios for "fiduciary advisers" and, in turn, their plan participants. Serving as a "fiduciary adviser" and delegating the participant contact to associate advisers. In this case, the fiduciary adviser would retain supervisory responsibility for the advice. With either of the models or their derivatives, the investment fiduciary and the fiduciary adviser are required to demonstrate that their compensation is fee neutral — that is, there is no variability in the adviser's compensation. The PPA has defined "fee neutral" or "level comp" as an arrangement where the adviser's compensation is not affected by which investments are selected. Fiduciary advisers face a new challenge in determining compensation, which must be fair and reasonable. Only a small percentage of participants (about 10% to 15%) will take advantage of the services of the fiduciary adviser at any one time. So charging an asset-based fee on all the assets in the plan, or a participant-based fee may not be reasonable. Forward-looking investment advisers have begun to position their business to serve the retirement market to capture the assets that flow out of plans into rollover accounts and have seen the value of capturing participant household assets. Those who don't develop personal relationships with participants lose assets to retirement rollovers. Most recognize that in the long run, commissions will not be viable compensation for advice and are converting their clients into investment advice ar-rangements. Knowledgeable advisers see the opportunity to use the new features of the PPA, such as QDIAs and advisory services to participants, to transform their business and win new clients. Don Trone is president of the Center for Fiduciary Studies and chief executive of Fiduciary360 LLP, both in Sewickley, Pa. Louis S. Harvey, president of Dalbar Inc. in Boston, contributed to this column.