Does your 401(k) plan have an investment policy statement (“IPS”)? According to Callan consultants, some 90% of defined contribution plans maintain an IPS. Historically, however, larger plans are more are far more likely to develop the document than smaller retirement plans.
But not every plan that has an IPS keeps it close at hand. Fewer than two-thirds of plans have reviewed their investment policy statements in the last 12 months.
Just what is an investment policy statement?
The investment policy statement is a document describing criteria for your company’s retirement plan investments and their ongoing evaluation. Ideally, while this document will provide appropriate policies for investment selection and monitoring, it will avoid specifics that then can limit the committee’s discretion, or force them into a decision. The IPS should serve as a roadmap, but not provide the committee with turn by turn directions.
What should an investment policy statement do?
A solid investment policy statement defines the role of the investment committee, and provides guidance on what investments should be included in the plan. The statement should describe the plan’s investment philosophy and provide general guidance on how the fund menu should be constructed. For example, should the committee merely be given instructions to include equity, fixed income, and money market funds? Or should they also be instructed to consider equity funds of various investment styles?
The investment committee’s job is far from over once it selects the investments. That’s why the IPS should describe how the investment committee should monitor the fund line-up, and it should instruct them about circumstances that could be cause for removing a fund from the plan.
Why is a 401(k) investment policy statement important?
A roadmap for selecting 401(k) investments helps keep the plan’s offerings consistent. And well-defined criteria for regularly evaluating the investments ensures that the fund managers are investing the plan’s assets in a manner consistent with your expectations.
Once in place, a 401(k) investment policy statement can provide evidence that the plan sponsor is dutifully acting as a fiduciary when it comes to overseeing the plan’s investments. This can be critical information for your auditor, or even the Department of Labor.
Once you have this document put together you should follow it. Remember you are a fiduciary to your employees (some might say an employee fiduciary) when you offer a defined contribution plan as a benefit. Violations of the policy can be considered a fiduciary breach.
That’s all the more reason to take care that your IPS does not prevent the committee from taking an action they deem appropriate, or force them into an action they might not otherwise take.
Seven things to consider including in your investment policy statement
- Plan Purpose: This is an explanation of why the plan exists. It also acknowledges that the investment policy statement is the go-to document for guidance on selecting and monitoring investment options.
- Investment objectives/capabilities: These objectives might include providing enough investment options or fund categories so that participants can invest according to their risk tolerance and time horizon.
- Guidance on monitoring investments: The statement should specify how often the fund line-up should be reviewed and what criteria will be used to evaluate the investments. It is possible to provide a list of criteria to review without mandating that a fund be automatically replaced if its one-year performance lands it in the bottom quartile, for example. In fact, a qualitative review can be just as revealing as a slew of calculations. Has the manager changed his investment style? Is the manager trading more frequently? Does the fund have a new manager? The 401k) investment policy statement can also provide guidance on evaluating passive investments. Perhaps a significant deviation from the underlying index (tracking error) warrants further scrutiny. The IPS should provide the investment committee with the tools to remove a fund from the line-up – without forcing them to do so.
- What assets classes will be included: Here, for example, the committee can be instructed to include equity, fixed income, and money market funds in the plan. The IPS might also require the investment committee to include (or at least consider) different types of equity funds for purposes of diversification. These might include value and growth styles, or require that the committee consider small cap, mid-cap, and large-cap equity funds. The statement could also require the investment committee to consider non-US equity and fixed income funds. The statement needs to be carefully worded as to whether the asset classes are mandated or should merely be considered. For example, the document could list each asset class that must be represented by one or more funds.
- Instructions on how to select investments/Approach to performance and measurement: The document can suggest what characteristics should be considered when choosing a particular investment. One example is that the policy may limit investment managers to ones that are a bank, insurance company or investment management company or an investment adviser under the Registered Investment Advisers Act of 1940. Additionally, the statement could suggest that the committee review long-term investment returns, volatility measures, expense ratios, and manager tenure. It is important to provide guidance to the investment committee without forcing them to select a fund based on one or two metrics.
- Establishment of default fund: Here the statement would instruct the committee on whether or not to invest contributions without investment instructions into a particular fund. If so, then the document should explain how that fund (those funds) should be selected. At ForUsAll, we like low-cost TDFs as the plan’s Qualified Default Investment Alternative (QDIA).
- Participant education: By spelling out the requirements for employee education, the IPS can increase the odds that employees know how the plan works, and that they understand basic differences between fixed income and equity investments. The statement might mention the opportunities available to learn more about how the plan’s investment offerings can help meet their financial goals.
At ForUsAll, we know the Department of Labor doesn’t require an investment policy statement. But it does require that plan sponsors offer prudent investment options, and regularly assess your funds’ performance and appropriateness for the plan’s participants.
That’s why we think it is critical for prudent investment fiduciaries to establish an IPS for the plan, stating the underlying principles on how the plan investments will be chosen and reviewed. Any fund options that are no longer prudent should be removed from the fund lineup. This should be done regularly to provide appropriate investment selections and reduce legal liability. Since DOL audits do happen, the fiduciary needs to regularly review and carefully document the process and decisions related to the investments in the plan.
Unless your company has hired a 401(k) advisor who is acting as a 3(38) fiduciary, the role of the fiduciary rests on your company’s shoulders. A strong retirement plan advisor, with real experience working with defined contribution plans, can really help remove this workload from your team’s shoulders.