Public funds are following corporate lead by unitizing

Public defined contribution plan executives are considering unitizing, a strategy corporate 401(k) plans began using 20 years ago.

Consultants say fee transparency is the main driver.

Unitizing involves blending a plan sponsor's defined benefit money managers to create mutual fund-like separate accounts for a companion defined contribution plan.

Among the public funds interested in unitizing:

• the $4.7 billion Municipal Employee Retirement System of Michigan, Lansing, unitized in October;

• the $50 million Sedgwick Deferred Compensation Plan, Wichita, Kansas, included unitizing questions on a recent RFP; and

• the $1.4 billion Vermont State Teachers' Retirement System, Montpelier, plans to discuss unitizing with its consultant.

Consultants also said executives at corporate 401(k) plans are showing renewed interest in unitizing because of an increased focus on fees and the recent wave of revenue-sharing lawsuits.

Last fall, companies including Lockheed Martin Corp., Bethesda, Md.; United Technologies Corp., Hartford, Conn.; Northrop Grumman Corp., Los Angeles; Caterpillar Inc., Peoria, Ill.; General Dynamics Corp., Falls Church, Va.; Bechtel Corp., San Francisco; Exelon Corp., Chicago; and International Paper were sued over revenue-sharing agreements, when providers receive compensation from other vendors.

Phil Seuss, a Chicago-based principal at Mercer Human Resource Consulting, said public and corporate plans alike are looking for ways to reduce costs, have more fee transparency and get more flexibility among investments.

Mr. Seuss said Mercer has two public plan clients discussing unitizing their funds. He declined to identify them.

On the corporate side, Mr. Seuss said, boards of directors say: "We have a DB plan here and a DC plan here. Why aren't we using the same fixed income for all our plans?"

William Schneider, managing director at consultant DiMeo Schneider & Associates LLC, Chicago, said DC plans continue to look more and more like DB plans, and unitizing fits right in.

"When you have 20 options in a plan, even the very sophisticated participants don't understand everything. The next step in the evolution is the time-targeted funds, but they have a fatal flaw. The flaw is they are using proprietary funds, of which some are great, some are OK, and some are crappy," said Mr. Schneider.

"What we've done is put in target funds using options in their own plan. Why wouldn't you have best of breed? Fidelity is good at managing money, but maybe not at allocating assets. Couldn't you do it better with managers running separate accounts? And it's cheaper."

Mr. Schneider added: "In the retail mutual fund world, you have fees built in to cover all the shareholder services. If you could eliminate that and reduce your costs, why wouldn't you? Plus, you can't negotiate with a mutual fund. Clients could negotiate with the money managers" if they decide to unitize.

Robyn Credico, a consultant at Watson Wyatt Worldwide, Washington, said more corporate plan executives are asking about unitizing. She agreed that cost and investment flexibility are key drivers among corporate and public DC plan executives.

"We have been encouraging large (corporate) plans to look at separate accounts and commingled funds. At least five or six have done it" in the last couple of years, she said. She wouldn't name any.

John Carbone, managing director for Hartford Life Insurance Co., Simsbury, Conn., said fee transparency is the reason unitization is being more widespread. "You have seen that a lot on the corporate side for years, and now we're starting to see it on the public (side)," he said.

Some plans are reluctant to unitize because of participant resistance or increased work for the plan's staff.

"One of the challenges is that participants want name recognition. They want to be able to look up a ticker symbol, and companies are not branding any of these funds," said Ms. Credico.

"(Unitized plans) require more hands-on time for the staff to monitor and manage it. The annoying bits become more time consuming. It's a tradeoff. You have to do more work to inform participants. It's no longer just a ticker symbol and Morningstar statistics," said Anne Lester, portfolio manager at JPMorgan Asset Management, New York.

Despite the challenges, consultants say unitzing will become a larger trend on the public side in the next couple of years.

Michigan Muni, which unitized in October, created the Total Market Fund Portfolio, managed by the fund's investment staff, for 457 plan participants.

According to the system's website, officials decided to unitize to give DC participants access to the same "cost effectiveness and superior risk-adjusted returns that are enjoyed by the MERS defined benefit members." The system's investment staff also manages the defined benefit plan's investments. Jeb Burns, chief investment officer, for MERS, did not return three calls.

The portfolio has 36.5% in domestic equity, 15% international equity, 25% fixed income, 5% high-yield bonds, 8% private equity, 7% real estate, 2% commodities and 1.5% cash.

Sedgwick County, in a recent bundled provider RFP, asked if providers could unitize plan assets. Ron Estes, treasurer of Sedgwick County, did not return two calls.

And, in Vermont, fund officials expect to decide about unitizing this year, in hopes of saving money, according to the state treasurer's website. Treasurer Jeb Spaulding and David Minot, director of finance and investments at the Vermont plan, did not return calls seeking comment.

"The focus on costs will push many more public plans to look at it (unitizing). They are realizing the amount of assets they have and see that they have two plans doing the same thing with two different boards doing the same thing," said Mr. Seuss.