No matter which particular legislative backdrop you happen to operate in, the fiduciary role is a demanding one. Those who are responsible for managing other people’s money are in an unenviable position. In the widely-quoted language of a 1928 New York Court of Appeals judgement, “A trustee is held to something stricter than the morals of the marketplace. Not honesty alone but the punctilio of an honor the most sensitive is then the standard of behavior.”[1]
A natural reaction to this heavy responsibility is to become risk-averse. And, in particular, to stick with the crowd. But this is not always in the best interest of the plan participant.
The faint-hearted fiduciary won’t create the change that is needed
It’s largely a question of incentives. The payoff patterns for the fiduciary and the beneficiary frequently differ. Consider this simplified example: suppose a position is judged as having an equal probability of generating either an extra dollar of gain or fifty cents of loss. This position is, from the point of view of the beneficiary, generally a good position to take: there’s more upside than downside.
But the outcome won’t necessarily be perceived that way. The fallout from a loss arising from a non-traditional approach can attract scrutiny and criticism, heavily spiced up by the benefits of hindsight. So the downside for the fiduciary is not just the fifty cents of potential loss but also the fallout that would accompany it, fallout which does not have a corresponding benefit on the upside. This can be a deterrent for the fiduciary.
For defined contribution (DC) fiduciaries around the world who want to do the right thing by their plan participants, this is not just a hypothetical discussion. As we’ve set out in the paper Proposing a stronger DC purpose, most DC plans around the world are trying to solve the wrong problem: instead of focusing on income provision throughout the whole post-work period, too many plans are operating as if their purpose is the maximisation of savings at the point of retirement, which is a much narrower goal.
There’s a need for change; the DC world is crying out for fiduciaries to stand up and change the focus of the industry. It’s the right thing to do. But it’s not the easy thing to do. The faint-hearted fiduciary will hide in the crowd.
I have bad news for the faint-hearted fiduciary. As the old saying goes: sometimes the biggest risk in life is not taking one. Sometimes keeping your head down means that you aren’t doing your job. Fiduciaries are expected to make their own interests secondary. They shouldn’t be setting their course according to their own payoffs, but according to those of the beneficiary. Failing to act in those interests is failing to live up to the fiduciary standard.
Brave, but not foolhardy
So the truly wise fiduciary realises that there comes a time to step away from the (apparently) safe position of sticking with the conventional approach. That is, clearly, not to be done lightly. So let’s be clear that changing the focus of the DC system from savings to lifetime income provision is unequivocally in the interests of plan participants. The reason it’s difficult is because the incentives acting on the various actors in the system discourage change. Recognising this, and doing what needs to be done to change the picture, is what the fiduciary is there for.
And let’s be clear, too, that fiduciaries who depart from the conventional approach need to take care to document their rationales; documentation that is made at the point of the decision can be a powerful counter to accusations based on hindsight. Good fiduciaries know that they need to ensure not only that their actions are prudent, but also that they can be shown to be so. That’s doubly true in a situation such as this.
The need for good documentation applies, too, to those who choose to stick with the current approach. Some fiduciaries may reach the conclusion that, in their particular circumstances, participants’ best interests really are served by a focus on asset accumulation. They too have a duty to demonstrate why that is the case, to ward off accusations of self-interest.
Or is regulation the answer?
One way to shortcut the issues described above could be a regulatory push. For example, in the early 2000s, U.S. DC fiduciaries faced a thorny situation regarding what to do with the savings of those who had been defaulted into the plan and had not selected an investment strategy: a situation with close parallels to the situation we’ve described in this article. In an aggressively litigious environment, fiduciaries were reluctant to expose assets to any risk of capital loss – and frequently made choices that were demonstrably ineffective as long-term investment strategies as a result. It took a legislative safe harbour[2] to resolve that particular dilemma.
Perhaps it’s going to take a similar intervention from outside the industry to resolve the current situation and re-align the focus of the system. If so, shame on the faint-hearted fiduciaries who left it to others to do their job.