Chamberlain Financial Planning

By admin 　http://chamberlainfp.com/2010/06/suggested-best-practices-for-selecting-and-monitoring-investment-options/

To start, the plan sponsor should be fully aware of their ERISA responsibilities. Next the processes of selecting and monitoring the investment options need to be in writing as well as how often they are reviewed and the criterion for replacing investment options.

Having the correct asset allocation has been shown to be the major factor in determining portfolio returns. Having the appropriate major asset classes available is very important. Than comes the selection of suitable investments in each of those asset classes. This can be accomplished via a screening methodology. The screening options could or perhaps should be:

• Product is available from desired custodian: The product must be available from the custodian that is utilized. Not all funds are available everywhere. If many options are eliminated, consider a new custodian.
• Available to new investors: The product must be available for purchase by new investors. Some funds are closed to new investors.
• No “Loaded” funds: The product should not have commissions paid to service vendor/salesman.
• Expense ratios/fees relative to peers: The fees of the product should not be in the most expensive half of their peer group. These would include; Net Expense Ratio, all fund management costs, 12-b1 fees, administrative fees, and all other asset-based costs incurred by the fund, with the exception of brokerage costs.
• Composition consistent with asset class: At least 80% of the securities in the product should be consistent with the asset class.
• Style consistency: The product must be highly correlated to the asset class of the Morningstar Style Box®. Since asset allocation is the prime driving force of return, it does not make sense to use products that change their style over time.
• Risk-adjusted performance relative to peers: The product’s risk-adjusted performance should be above the peer group median risk-adjusted performance. (Alpha and Sharpe Ratio)
• Performance relative to peers: The product’s performance should be above the peer group’s median manager return for various cumulative time periods.
• Minimum track record: Actively managed products should have at least three years of history so that performance statistics can be properly evaluated.
• Assets in the fund: The product should have at least $75 million of assets.
• Regulatory oversight: The product should be managed by: (a) a registered investment company (mutual fund), (b) an insurance company, (c) a bank or (d) a registered investment adviser. Unregistered products are not included.
• Proprietary Fiduciary Score: A fiduciary rating is provided on a quarterly basis from a low of 100 to a high of 0. Using those in the top quartile would be “prudent” to consider.

Example: We wish to find a suitable investment of the “Small cap blend” asset class. Of all the funds that meet the regulatory oversight criterion, there are 22,125 mutual funds and ETF options. The following screens are applied and you can see the remaining funds to consider after the screening.

Of these 16 options that remain, the plan fiduciary or committee would chose a fund for the asset class based on all factors. In this case, the Schwab Small Cap Index (SWSSX) was chosen with a total cost of 0.19% a year. Had the plan been larger or the plan used a different custodian a different fund could have been selected with expenses as low as 0.09%

Note that with this methodology there are no limitations as to the investment options, Morningstar ratings, or past investment performance. This process is objective and repeatable, thus it meets the criterion for operating a plan “prudently.”