Defending the Indefensible
In recent years more and more class action lawsuits have been brought against corporate and university Defined Contribution (DC) pension plans for alleged violations of their fiduciary duties under the Employee Retirement Income Security Act (ERISA). Standards in DC plans have often been low in terms of selection, monitoring and removal of investment options in the plan among many other issues. First, we outline how to properly design a defined contribution plan that avoids most alleged fiduciary breaches and thus minimizes the likelihood of ERISA litigation in addition to optimizing plan participants’ investment outcomes. Second, with regard to the ongoing ERISA litigation, we discuss several conceptual and practical claims frequently made by defense experts that are inconsistent with investment theory and practice. Defense experts are generally held to a lower standard than plaintiff experts and can use misplaced anecdotes, conceptual errors, and violations of best practices criteria. By identifying such claims, we hope to improve common practice in the best interest of plan participants.
Published paper: Defending the Indefensible, The Journal of Retirement 2024, forthcoming.
© 2024 PMR. All rights reserved.
The Exchange Traded Fund Landscape: Past, Present, and Future?
Exchange-traded funds (ETFs) have revolutionized the investment universe since their inception in 1993. They are indubitably one of the most successful investment structures in history. Their transparency, transactional superiority, tight arbitrage-based pricing, tax efficiency, and low fees are all contributing factors to their success. The authors expect their growth to continue at the expense of both mutual funds and other structured products, particularly as regulatory constraints are removed. ETFs are more difficult to operate when the underlying isn’t transactionally liquid or easily valued. For this reason, the authors don’t expect all ETFs to be successful. ETFs that use derivatives as underlying possess some unattractive characteristics that need to be thoroughly understood by investors. ETFs based on thematic strategies are often driven more by investor exploitation than sound investment thesis and will continue to underperform. This underperformance creates opposing dynamics in terms of both fees and assets under management. In this article, the authors offer an overview of the current ETF market, particularly focusing on recent developments in this area.
© 2024 PMR. All rights reserved.
How Long is Long Enough?
Defined Contribution (DC) Plan (DCP) fiduciaries are often faced with conflicting perspectives when it comes to executing their responsibilities and terminating underperforming active managers. Consultants, academics, investment managers and capital market intermediaries generally argue that more time is needed to prove an investment strategy is suboptimal. These parties often have inherent conflicts of interest to argue for active management over passive management. Most conflicts are economic in nature, but some are steeped in intellectual hubris. In this article we enter the fray from the plan participants’ (PP) side. Ultimately, the very essence of a DCP is to offer a menu of investment options that enable PP to optimize wealth aggregation in a diversified manner using a multi-asset class solution. We show that PP are better served when fiduciaries monitor active investment managers and replace them with passive alternatives in a timely manner if they underperform. Too often plan fiduciaries churn a DCP by replacing underperforming active funds with other active funds.
Published paper: How Long is Long Enough?, The Journal of Retirement Fall 2020, 8 (2) 39-48.
© 2020 PMR. All rights reserved.
Active Management in Defined Contribution Plans
We analyze the problem that fiduciaries face when monitoring and selecting from a universe of active mutual funds within a defined contribution (DC) plan. In a DC plan a fiduciary must recognize that there are two levels of decision makers, namely the fiduciary who decides which funds will comprise the DC plan and the individual plan participants who must decide which funds to invest in and the timing of their investment. Moreover, plan participants, and to some degree the fiduciary, need to be able to make investment decisions without being an investment professional.
We find that due to the general lack of consistency in performance of mutual funds, fiduciaries and plan participants would be better served by selecting passive rather than active funds across the US equity mutual fund space. Moreover, the most consistently outperforming funds tend to have meaningfully higher tracking errors relative to their stated benchmarks which makes effective asset allocation in a DC plan more difficult.
© 2020 PMR. All rights reserved.
Introducing the Power Series Method to Numerically Approximate Contingent Claim Partial Differential Equations
We introduce a previously unused numerical framework for estimating the Black-Scholes partial differential equation. The approach, known as the Power Series Method (PSM), offers several advantages over traditional finite difference methods. The PSM is more stable than explicit methods and thus computationally more efficient. It is as accurate as hybrid approaches like Crank Nicolson and faster to compute. It is more accurate over a far wider spectrum of time steps. Finally, and importantly, it can be expressed analytically thus offering the capability of performing comparative statics in a far more stable and accurate environment. For more complex application this last advantage may have wide implications in producing hedge ratios for synthetic replication purposes.