We believe it’s a fiduciary’s responsibility to seek understanding so that they are comfortable and confident in the decisions that they make. We’ve provided a glossary of terms that are often used during retirement plan committee meetings to help ensure that you are knowledgeable about the plan and can engage in discussions with your advisor.
Asset allocation
The mix of stocks, bonds, and cash equivalents. Fiduciaries should understand the asset allocation of any balanced/target retirement date/investment portfolio offered under the plan. Asset allocation is an important determinant of investment performance and an investor’s asset allocation should align with their risk level.
Glidepath
Generally associated with target retirement date funds or investment portfolios. It’s a representation of how the asset allocation of the investment changes over time. As investments become more conservative and approach retirement, their asset allocation shifts from stocks to bonds.
Maturity
A bond fund’s maturity represents the weighted average time remaining until the bonds held within the fund mature. Short-term bond funds generally have a maturity between 1 and 3 years and long-term bond funds generally have a maturity greater than 10 years.
Duration
A bond fund’s duration is a measure of its interest rate sensitivity. Shorter term bond funds will have a lower duration and longer-term bond funds will have a higher duration. For example, if a fund has a duration of 5 years, for every 1% rise in interest rates the fund will lose about 5% of its value. With that same 1% rise in interest rates, a fund with a duration of 15 years will lose about 15% of its value.
Average credit quality
A bond fund’s average credit quality is the weighted average of the underlying bonds’ credit ratings. Bonds that are rated AAA/AA/A/BBB are considered investment grade quality. Bonds that are rated BB and below are considered high-yield or junk bond funds.
Rolling returns
Rolling returns is a calculation of performance that averages returns over overlapping periods. For instance, if you want to calculate a 3-year rolling return over the last 10 years, you will first calculate the 3-year return for the first 3-year time frame. Then you would calculate the 3-year return for the subsequent 3-year time frames over that 10-year period. Finally, you would average all the 3-year returns that you calculated. The benefit of looking at rolling returns is that it helps to smooth out the impacts of market volatility.
Morningstar
A recognized leader in providing investment research, ratings, investment analysis and market data.
Morningstar rankings
Morningstar categorizes mutual funds based on their investment focus such as domestic mid cap blend or short-term bond. Then within each category the rank shows performance compared to peers. For example, if a fund has a rank of 90, it means that 90% of other funds within that category had better performance.
Morningstar ratings
Morningstar assigns star ratings to mutual funds. Star ratings are a backward-looking measure of a fund’s past performance. Morningstar uses historical risk adjusted returns to rate funds from 1-5 stars. 5 stars is the highest rating; 1 star is the lowest.
Morningstar’s 9 style box—Morningstar divides a fund’s investment style into one of 9 style boxes. For equity mutual funds, there are 3 rows that denote the size categories of large, mid, and small and then three columns that denote the style categories of value, blend, and growth. For fixed income mutual funds, there are 3 rows that denote credit quality of high, medium, and low, and three columns that denote duration of short, intermediate, and long term.
Turnover ratio
A mutual fund’s turnover ratio measures the percentage of the fund’s holdings that are traded within the year. A turnover ratio of less than 10% indicates a buy and hold strategy like index funds. Actively managed funds can have turnover ratios over 100%, which would indicate making numerous short-term moves based on current market conditions.
Standard deviation
A mutual fund’s standard deviation is a measure of its volatility. Standard deviation measures the spread of a fund’s return around its average return. The higher the standard deviation, the more volatility one can expect. Generally speaking, two-thirds of the time, returns are within a band of 1 standard deviation of the average return and ninety-five percent of the time, returns are within a band of 2 standard deviations of the average return. For example, if the fund’s average return is 15% and the fund has a standard deviation of 10%, then one can expect that most of the time (95% certainty) the return would fall between -5% and 35%.
Tracking error
A fund’s tracking error tells you to what degree the fund’s performance deviates from that of its benchmark. The fund could track its benchmark very closely but still have a high standard deviation.
Revenue sharing
Revenue sharing is a part of a mutual fund’s expense ratio. It represents the portion of the expense ratio that is rebated back to a provider, generally the recordkeeper. Revenue sharing can be used in different ways, including being returned to participants invested in the funds that pay revenue sharing or retained by the recordkeeper as additional compensation. Fiduciaries should understand which funds pay revenue sharing and how that revenue sharing is being used. Using revenue sharing to pay for the recordkeeper’s compensation, could lead to some participants paying more for recordkeeping fees than others. Fiduciaries should be taking steps to ensure that this additional compensation is reasonable and that participants are being treated fairly.
Forfeitures
Forfeitures occur when a participant separates service before being fully vested in their retirement plan. These dollars, which are not paid to the participant, are deposited into a forfeiture account. Generally, these dollars are invested in a cash equivalent investment. The retirement plan document outlines how these forfeiture dollars can be used. Generally, they are used to offset plan expenses or lower the employer’s future contribution. It may be advisable to have the plan document be specific as to how these dollars are used.
ERISA 3(21)
ERISA 3(21) refers to a section of the Employee Retirement Income Security Act of 1974. An investment advisor is a fiduciary if they provide investment advice for a fee. Under this arrangement, the advisor typically makes recommendations, but the plan sponsor needs to approve prior to implementation. The decision and legal responsibility remain with the plan sponsor.
ERISA 3(38)
Under this arrangement, the advisor is considered the investment manager. They generally have discretionary authority and full responsibility to select and replace investments.
ERSIA 404c
ERISA 404c refers to a section of ERISA that aims to protect fiduciaries from liability from participant claims of investment losses. To qualify for 404c protection, the plan sponsor needs to meet certain requirements. They include offering a range of investment options, providing participants with information so they can make informed decisions, and allowing participants to change their investments. Form 5500 poses a question as to whether or not the plan intends to meet the requirements of 404c.
ERSIA 408(b)(2)
ERISA 408(b)(2) refers to a section of ERISA that provides an exemption if the compensation paid to a party-in-interest for necessary services is reasonable. This exemption is contingent upon the provider supplying the plan sponsor with a disclosure that outlines their services and fees. It is important for plan sponsors to review fees to help ensure that participants are paying only reasonable expenses.
Have questions?
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