Some critics contend the 401(k) concept is broken and has failed its basic mission to fund the great American retirement. Avatar Associates begs to differ.

The New York City-based institutional money manager serving financial advisors and others gets roughly half of its revenue from the 401(k) market, and expects that to rise to 75% to 80% over the next five years. Its foundation is a quantitative investment process that puts less stock in standard financial models and more emphasis on a "weight of evidence" approach that takes a range of economic and market indicators and puts them in a blender to divine which way the investing winds are blowing. Avatar employs a tactical allocation approach it says enables it to react to changing market conditions and mitigate volatility, while building its portfolios solely with low-cost exchange-traded funds across various asset classes.

But while 401(k) plans help Avatar pay the bills and then some, the company isn't an apologist for the industry's perceived shortcomings. If anything, it has been pushing for reforms to make retirement plans more effective and plan providers more accountable to plan sponsors and investors.

Larry Medin, the company's president, has worked with Congress, the Securities and Exchange Commission and the U.S. Department of Labor on 401(k) issues, and before he joined Avatar played a role in making the Pension Protection Act of 2006 possible. Among other things, this regulation amended the Employee Retirement Income Security Act (ERISA) to provide a safe harbor for plan sponsors to invest participant assets in qualified default investment alternatives (QDIAs) when participants fail to provide investment direction for their accounts. This act has been credited with boosting 401(k) plan participation and savings rates.

And with the U.S. Department of Labor currently considering a proposal to redefine who should be a fiduciary in the retirement planning space under ERISA, Medin is on his soapbox stating that mutual fund companies, which currently are exempt from fiduciary status under ERISA, should be held to that standard. It's that exemption, Medin says, that helped cause the disappointing performance of target-date funds-an increasingly popular QDIA in 401(k) plans-during the market downturn because fund companies made conflicted choices by stocking their target-date funds with their own proprietary funds rather than picking the funds best-suited for market conditions at that time.

"To say the vast majority of assets moving into the QDIA space-target-date funds among them-will be excluded from fiduciary responsibility is absurd," Medin says.

The 401(k) industry has been plagued by low participation and savings rates, allocation problems such as heavy weightings in company stock, and failed efforts to educate the public on how to get it right. "I think 401(k)s were broken, and they've been partially repaired," Medin says. "The Pension Protection Act was a tremendous step in the right direction, but a lot of things still need to be done."

One of those things was Rule 408(b)(2), a Labor Department regulation issued last summer that was scheduled to take effect this July. Recently, that start date was pushed back to January 2012. The regulation will impact both defined contribution and defined pension plans subject to ERISA, and will require providers and plan sponsors to clearly disclose the services being provided, explain who gets paid for what, highlight built-in conflicts of interest and say whether the investment provider is acting as fiduciary of the plan. The name of the game is to boost transparency, help sponsors better manage their plans, control risks and reduce fees for both plan sponsors and participants.

And now there's the Labor Department's re-examination of who exactly should be a fiduciary under ERISA. Avatar believes these mandated--and potential--changes "will be like a tsunami washing over the 401(k) market that will require each plan sponsor to re-evaluate the current arrangements and carefully consider products and services like Avatar's," says Dan Carlson, the firm's chief marketing officer.

Diffusion Index
Avatar was formed in 1970 and entered the 401(k) space in 2006. It's making a bigger name for itself there, but it might be known by some people more for one of its co-founders, noted investor Marty Zweig, and a couple of aphorisms he coined back in the day--"Don't fight the Fed" and "Don't fight the tape." These concepts speak to the role of monetary policy and market performance on investment management, and they guide the firm's philosophy to this day along with the non-mainstream market views of Zweig, the firm's first research director, and Avatar's other co-founder, Ned Babbitt.