The threat of litigation, or perhaps more realistically the perceived risk of litigation, has been a common topic of debate in the UK defined contribution (DC) market for many years. It is often raised in discussions surrounding fund choice, the closing down of funds, whether the options should be active and/or passive, and of course ‘benefit of hindsight’ performance concerns. Fortunately, although there have been examples of the courts being involved in plan disputes, some quick research highlights few UK examples. However, the same cannot be said for the U.S. market.

From engaging with clients and consultants alike, it is clear to us that those running DC plans in North America are alive to the threat of litigation, and are quite right to be. In a discussion with a consultant about the role of an absolute-return strategy in a target-date fund, the key issue revolved around fees – not because of concerns about ‘value for money’, or indeed the appropriateness of the strategy, but because any strategy that is not offered at a passive fee is felt potentially to open the plan up to litigation.

When I researched the topic, it was clear that litigation and DC do seem to go hand in hand in the U.S. As one eye-catching, if rather crass, headline put it: “401(k) Litigation: The ‘Next Asbestos’?”. The resulting impact on plan sponsor behavior is telling. As highlighted in the 2017 Callan DC Survey, sponsors now see reviewing fees as being far and away the single most important act for improving the fiduciary position of their DC plan.

So what does this mean? In a quantitative easing-fueled world where markets have appeared generally only to go up, it could be argued that it’s all about fees. But in a world where that trajectory may change, and where participants are facing investment challenges that are more demanding than ever (owing to flexibility and the low-yield environment), we suggest that plan sponsors and trustees will need to offer better solutions. However, in order to better ‘protect’ themselves from ‘benefit of hindsight’ litigation risk, we believe plans must have a bespoke governance structure, reflective of their governance resource, which captures the objective of the plan, the investment philosophy and beliefs, and the decision-making process.

By defining objectives (including the role and aims of the default strategy), and having a robust and frequent review mechanism (with external support and advice if needed), we think plans can deliver a genuine ‘value-add’ DC arrangement rather than simply taking a ‘risk-free’ approach. While fees may be the issue today, should participants reach retirement and find their pots are not of a sufficient size, the whole investment proposition could come under scrutiny.

This is a financial promotion. Material in this publication is for general information only. The opinions expressed in this document are those of Newton and should not be construed as investment advice or recommendations for any purchase or sale of any specific security or commodity. Certain information contained herein is based on outside sources believed to be reliable, but its accuracy is not guaranteed. You should consult your advisor to determine whether any particular investment strategy is appropriate. This material is for institutional investors only. Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell this security, country or sector. Please note that strategy holdings and positioning are subject to change without notice.

Important information

This is a financial promotion. Material in this publication is for general information only. The opinions expressed in this document are those of Newton and should not be construed as investment advice or recommendations for any purchase or sale of any specific security or commodity. Certain information contained herein is based on outside sources believed to be reliable, but its accuracy is not guaranteed. You should consult your advisor to determine whether any particular investment strategy is appropriate. This material is for institutional investors only.

‘Newton’ and/or the “Newton Investment Management” brand refers to the following group of affiliated companies: Newton Investment Management Limited and Newton Investment Management (North America) Limited (NIMNA Ltd). In the UK, NIMNA Ltd is authorized and regulated by the Financial Conduct Authority in the conduct of investment business and is a wholly owned subsidiary of The Bank of New York Mellon Corporation. Registered in England no. 2675952. NIMNA Ltd is registered with the SEC as an investment adviser under the Investment Advisers Act of 1940. NIMNA Ltd’s investment business is described in Form ADV, Part 1 and 2, which can be obtained from the SEC.gov website or obtained upon request.

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Certain information contained herein is based on outside sources believed to be reliable, but their accuracy is not guaranteed. Unless you are notified to the contrary, the products and services mentioned are not insured by the FDIC (or by any governmental entity) and are not guaranteed by or obligations of The Bank of New York or any of its affiliates. The Bank of New York assumes no responsibility for the accuracy or completeness of the above data and disclaims all expressed or implied warranties in connection therewith. © 2006 The Bank of New York Company, Inc. All rights reserved.

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