Category: Nonprofit Investing

Nonprofit Investing

Have Alternative Investments Helped Pensions?

A recent article in the New York Times points out that pension funds that have stuck to more traditional investments have outperformed pensions that have a higher concentration of alternative investments like private equity, hedge funds and real estate.  This begs the question are alternative investments worth it?  Based simply on the article its hard to judge given that the time period reviewed is such a short time horizon.  The pensions have much longer time horizons and over longer periods of time it is possible that these alternative investments could add value.  However, due to their high fee structures they must reach a significantly higher performance hurdle in order to deliver value.

The significant issue to be gleaned from the data presented in the article is that the alternative heavy portfolios underperformed despite a large financial shock that occurred over the 5 year time horizon examined.  Proponents of adding alternative investments to a portfolio argue that the investments provide diversification and downside protection from major financial shocks.  Many hedge funds seek absolute returns, meaning positive returns in all market environments and private equity investments are expected to provide performance uncorrelated with the stock market.  However, when these investments were needed most, in the throes of the Great Recession, they did not aid pensions’ portfolios.  If these investments are not providing the benefits their proponents claim then it should make investors think twice about an allocation.

New Retirement Plan Disclosure Requirements


The Department of Labor (DOL) has issued two new regulations aimed at empowering qualified retirement plan sponsors and participants to make better decisions with their plan assets.

1. Rule 408(b)2 will help sponsors obtain the information necessary to fulfill their fiduciary responsibility. With this information, plan sponsors must follow a ‘prudent process’ for determining that the services for which plan assets pay for are “reasonable”. Special attention must be paid to the fiduciary status of the entity providing services to the plan.

2. Rule 404(a)5 will make plan participants aware of the total fees that they pay for various investment related services. A written description of the services and total fees paid must be provided on the participants benefit statement.


In the most recent Deloittte “Annual 401k Survey”, 36% of plan sponsors indicated that they had difficulty obtaining a clear description of the fees associated with their retirement plan. When plan participants were asked in an AARP study whether they pay fees for their 401(k) plan, 65% reported that they did not pay any fees, and only one in six (17%) stated that they do pay fees, with the remainder not knowing whether they pay fees or not.

Over recent years, the way service providers are compensated (e.g., revenue sharing, selling agreements, or other “soft dollar” arrangements) has become increasingly complex. The complexity arising from these changes has also made it extremely difficult for many plan sponsors and fiduciaries to understand how and how much service providers are being compensated. This has been a major information gap that has prevented many sponsors from fulfilling their fiduciary responsibilities.

Additional information about rule 408(b)2

Under rule 408(b)2, service providers expecting to receive more than $1,000 in compensation over the life of their involvement with the plan must disclose the services they provide the plan, the total cost of such services, and their fiduciary status. These service providers include, but are not limited to, custodians, recordkeepers, third party administrators, and financial advisors.

All of the needed plan information can be obtained now that full disclosure is required by your service providers, but the disclosure alone is not the full picture. The plan sponsor must “ensure that arrangements with their service providers are ‘reasonable’ and that only ‘reasonable’ compensation is paid for services.” Plan sponsors must carefully consider these disclosures to determine if the agreements they enter into with their service providers are in-fact “reasonable agreements” for the level of services being provided.

Should there be an audit by the Department of Labor, plan sponsors will be asked to produce the agreements they have with their service providers that include the requisite disclosures. The auditor is also likely to want a description of the service provider selection process that was followed and to show evidence that a prudent decision making process was applied. Failure to comply with these requirements may result in prohibited transactions with substantial penalties.

Additional information about rule 404(a)5

The second aspect of the new DOL regulations is rule 404(a)5. This rule relates to the disclosures to plan participants that are in addition to the plan-related information that must be provided up front and annually. “Participants must receive statements, at least quarterly, showing the dollar amount of the plan-related fees and expenses (whether ‘administrative’ or ‘individual’) actually charged to or deducted from their individual accounts, along with a description of the services for which the charge or deduction was made. These specific disclosures may be included in quarterly benefit statements required under section 105 of ERISA.” These disclosures must be provided to plan participants prior to the applicability date of the regulation and any material changes trigger a required disclosure within 60 days of the effective date of the change.

Rule 404(a)5 allows for plan participants to gain ready access to a greater level of plan information including investment fees and plan expenses, for both “administrative” fees as well as “individual” fees, so they are able to make better decision with their investments. The plan level disclosures must include information regarding the right to direct investments, any plan restrictions, and a description of the types of fees and expenses associated with a plan account (e.g., loan origination fees, self directed brokerage fees, etc.). Any additional information requested by a plan participant must be made available, and the disclosure must be in writing.

Fiduciary Status

In addition to the amount of compensation being received, all fiduciaries providing services to the plan must also declare, in writing, their status as a fiduciary and what type of fiduciary role they are taking. This role can be a 3(38) fiduciary, who has the discretion to make investment changes to the plan, or a 3(21) fiduciary, who recommends investment changes for the plan and those changes are implemented by a 3(38) fiduciary.

Benefits of the Rule Changes

Rule 408(b)2 disclosure requirements can be of a great benefit to most plan sponsors who, up until this point, had difficulty in determining the amount of fees being charged to their plan and were unable to determine where conflicts of interest may arise. Substantial regulatory and litigation risks can be reduced by using this new information to review and select new service providers. Clear delineation of roles and responsibilities, including fiduciary status for various parties, will help hold all those involved responsible for their actions and promote the best interests of the plan participants.

Timing of the Rule Changes

1. Rule 408(b)2 is currently scheduled to go into effect on April 1, 2012
2. Rule 404(a)5 is currently scheduled to go into effect on May 31, 2012

No need to panic – but now is the time to start requesting the disclosure information and developing a formal process to make sure that each of your service provider’s fees are reasonable in light of their level of service and fiduciary status.

Next Steps

Once a plan sponsor receives compensation information from their providers, it is important to take the time to understand the fees and how their fees compare to industry standards. Reach out to peers, or review peer survey data to evaluate how the plan compares to industry standards. Plan sponsors may also want to submit a request for proposal (RFP) from various other service providers and/or financial advisors to determine what the competitive market is offering for similar services. It is not necessary to perform an RFP, as long as the plan sponsor has a documented prudent decision making process by which the current service providers were selected.

Sponsors will need to update or develop a written history of all fiduciary actions taken on behalf of the plan. Make sure there is a formal due diligence process outlined in the investment policy statement – and that this process is followed and documented.  Be cognizant of ways to lower expenses whenever possible without sacrificing benefits and services.

Finally, stay informed. Lawsuits and legislative changes can and will impact the plan over time; it is important to review the plan document and make any needed amendments.

Please don’t hesitate to reach out to Dennis Gogarty at Raffa Wealth Management with any questions. Dennis can be reached at 202-955-6734 or

1 Deloitte IFEBP Annual Survey, “Annual 401(k) Survey – Retirement Readiness”

2 AARP (2011, November 17).  401(k) Participants’ Awareness and Understanding of Fees.  Retrieved from

3 US Department of Labor (2011, November 17). Interim Final Regulation Relating to Improved Fee Disclosure for Pension Plans.  Retrieved from

4 US Department of Labor (2011, November 17). Interim Final Regulation Relating to Improved Fee Disclosure for Pension Plans.  Retrieved from

About Raffa Wealth Management

Raffa Wealth Management is an independent registered investment advisor offering highly customized investment consulting and portfolio management services to qualified retirement plans, nonprofits, and high net-worth investors.

Investment Reserves – Trust is not an Internal Control

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As the capital markets have become more complex and less transparent, the amount of risk inherent in a portfolio becomes more and more important – and harder and harder to measure.  The need for simple benchmarks that account for the level of risk in a portfolio has never been greater.

Such metrics bring clarity to performance reporting and effectively hold advisors and managers accountable for their results.  The challenge associated with accountability is particularly relevant in an environment where advisors often set the benchmarks against which their performance is measured, and prepare the reports that are used to understand their results. If you didn’t trust your advisors you wouldn’t be working with them.  Trust, however, is not an internal control.
This article, and accompanying worksheet, seeks to provide a framework for understanding and executing a simple, powerful portfolio benchmarking process.

We all understand well the relationship between risk and return.  As an investor or as a fiduciary, we need to know that we’ve been compensated fairly for the level of risk we’ve taken in any particular investment.  It’s important to have relevant context to understand if we’ve been fairly compensated for risk.  Context is made available through the use of benchmarks.

Back in the 1980’s, benchmarking was easy.  Investors typically invested in equity by owning the stock of large US corporations.  An easy, fair, and relevant proxy (or benchmark) for large cap US stocks is the S&P 500 Stock Index.  Investors typically invested in fixed income by owning bonds issued by the US Treasury, Government Agencies, or Large US corporations.  Easy, fair, and relevant proxies were readily available.

Since then, however, markets have evolved.  Not only has investing in traditional markets become more complex but limited partnerships (hedge funds) abound.  These complexities, compounded by a lack of transparency, make risk more difficult to understand and make it harder to identify fair, relevant benchmarks that give context to the results.

It’s helpful if you think about benchmarking from this perspective:  “My Association has decided that that we want 50% of our reserve portfolio to be invested in stocks and 50% in bonds.  We know that we could invest 50% of or portfolio in an S&P 500 stock index fund and 50% in an Aggregate bond index fund.  But, we are willing to hire someone that will give us the expectation that we can generate better returns – after adjusting for any additional risk and additional expenses.”

You should note that a portfolio comprised 50% in an S&P 500 index and 50% in an Aggregate Bond index is commonly referred to as an ‘institutional benchmark portfolio’ or as a ‘non -diversified portfolio’.

There are two ways that an advisor or manager can seek to earn better returns than the institutional benchmark (after both fees and risk are considered):

  1. 1. Asset Allocation
  2. 2. Manager Selection

It is necessary to use at least two benchmarks to identify if value is being added through either endeavor.

Asset Allocation

Through asset allocation, a manager or advisor will diversify beyond US large cap stocks.  A manager or advisor may choose to do any or all of the following:

  1. 1. Include small and mid cap stocks
  2. 2. Emphasize ‘value’ or ‘growth’ orientations.
  3. 3. Diversify internationally and or in emerging market countries
  4. 4. Invest in commodities or inflation adjusted bonds.
  5. 5. Utilize hedge funds, private investments, or other limited partnerships.

Regardless of how your manager or advisor chooses to diversify your portfolio beyond the ‘institutional benchmark’ portfolio, the institutional benchmark portfolio will always hold them accountable for having done so.

It’s important to note that your ‘institutional benchmark’ should consist of the percentage of stocks and bonds that your association has elected.  So, for example, if your Association has elected to have 60% of the portfolio invested in stocks and 40% in bonds your ‘institutional benchmark portfolio’ will be comprised 60% of the S&P 500 stock index and 40% of the BarCap Aggregate bond index.

If you allow your manager to determine the mix of stocks and bonds in your portfolio beyond a relatively narrow ‘rebalancing’ target range than I suggest you identify some static institutional benchmark to use as a guide to give context to their results.

Manager Selection

Whereas the ‘institutional benchmark’ will gauge the degree to which your asset allocation has added value, it’s not terribly helpful in indentifying if the individual managers or mutual funds selected for your portfolio have added value overall.  For this you’ll need a custom weighted benchmark.

This custom weighted benchmark will reflect your asset allocation and therefore it will more closely represent the risk level of your portfolio.  It will be comprised of the various individual asset class benchmarks that are a part of your asset allocation and each asset class benchmark will be assigned the weight that matches the weight each asset class is represented in your portfolio.  An example of such an asset class benchmark is the Russell 2000 Value index.  The performance of this index reflects the performance of small US company stocks with low fundamental valuations.  Including the returns of this asset class in the portfolio benchmark helps account for the greater risk (and return) expected from such an investment.

In order for this custom weighted benchmark to mirror your asset allocation over time, it will fluctuate as the weight of each asset class fluctuates with the market.  The performance of this custom weighted benchmark represents the performance of your asset allocation.  The difference between the performance of this custom weighted benchmark and your actual results is the value added or subtracted related to the managers or mutual funds selected in your portfolio.  The difference between this custom weighted benchmark and the ‘institutional benchmark’ is the value added or subtracted from your asset allocation.

Single Benchmark Solution

If you’re simply interested in identify value added period – not necessarily distinguishing between value added from asset allocation vs. manager selection, the ideal portfolio benchmark is a globally diversified, static benchmark balanced between stocks and bonds to match your organizations investment policy.
The following chart is an example of a detailed asset class breakdown and corresponding globally diversified portfolio benchmark for a portfolio invested 50% in stocks and 50% in bonds.

The indexes used in this benchmark provide comprehensive exposure to each of the equity asset classes (large/small) and styles (value/growth) around the world and to the entire US fixed income market. The weights are market neutral – meaning with no emphasis to a particular style or size. Use the spreadsheet that accompanies this article to easily benchmark the performance of your association’s reserve.

Benchmarking Alternatives

A simple, relevant way to benchmark alternative investment performance is to benchmark them against the traditional investment that they replaced.  Typically, alternative investments will be a replacement for stocks (Russell 3000), bonds (BarCap Aggregate Bond), or a balanced portfolio (60% stocks, 40% bonds).

There are certainly other issues that need to be considered.  Among them is comparing time weighted or dollar weighted returns and accounting for volatility.  Effective benchmarking practices are the answer and they should be clearly outlined in your organization’s Investment Policy Statement.


Raffa Wealth Management is an independent investment advisor providing nonprofit organizations, high net-worth investors, and qualified retirement plans with a full range of investment consulting services.  We were established to fill the need for transparency, clarity, and vision in the professional management of investment assets.   Visit us at