Actuarial models on which most defined-benefit plans were built are using unrealistic return assumptions. “And now [bond portfolios are] going to get you only 2%, 2.5% per year,” she continues. “And the problem that pensions have had is that their actuarial studies are assuming much higher returns than the market will give, at least in the next five to 10 years.”
To meet those funding levels, adds Todd, there’s going to be more adrenaline-fueled investing going on. Plans are going to be positioned much more aggressively, tilted toward equities, which creates more volatility.
“When you have volatility in a portfolio, that creates emotion,” he says. “And ultimately you still have individuals, trustees, making decisions, investment committee members making decisions, in at times an emotional environment. When that happens, they often make mistakes.”
Innovest now deals with 100 retirement plans, about 80% of them defined-contribution plans. One of the firm’s jobs is to quantify downside risk during downturns for clients.
Choices could become problematic. “A mistake we think investors make is they begin to reach for things because they have expectations that, in some cases, are unachievable,” at least without a lot of extra risk, Todd says. And though the firm preaches diversification, that message has been blunted by diversification’s perceived weaknesses among investors.
“International has been a drag on portfolios, bonds have been a drag on portfolios, so [investors] are looking for ways to ‘fix’ it, and when they try to fix things, they become irrational and they chase investments,” he says.
With DC plans, you are building a menu, Dominguez says. “We think it’s important to have both passive and active mangers represented,” as well small, large and international holdings.
It’s also Innovest’s job to get participants to save more, which will be the biggest contributor to better outcomes. And the firm will goad plan sponsors to offer better education programs, better matches, easier-to-use enrollment forms.
Dominguez says right now plan participants are asking for more dividend-paying stock funds. “That’s usually a signal to us that that’s the top of the market,” she says.
Todd adds: “Participants in plans are interested in making defined-contribution plans more defined-benefit plan-like.” That means there are more products appearing with guaranteed withdrawal benefits that you can contribute to on a paycheck-by-paycheck basis.
“But it sets a high watermark. It’s kind of like an annuity within a defined contribution plan,” Dominguez adds. “The problem with that is that it’s not real portable from a plan sponsor standpoint. So we’d like to see more portability.”
Whenever a DC plan has a big constituency that wants a certain product, Innovest will try to open a brokerage window in the plan. Sometimes the firm will link the plan up with outside advisors.
Growing Pains
Todd and Dominguez started the firm with another partner whom they eventually bought out when, about 10 years ago, the dynamic and vision of the firm started to change. Todd says, simply put, that there’s a lot of money in proprietary product, and the discussion of creating investment products for Innovest inevitably came up. That led to conflicts about the soul of the firm: Would it continue to burnish its fee-only, advice-driven brand or launch into a lucrative new area?
And that argument, says Todd, led to a bigger issue: Who was controlling the firm?
Todd says he realized something: “I am overbearing and influencing,” he admits. “And I was able to do things pretty much the way I want to do it. And I thought if I had control that meant freedom for me.” But the fact that so few people at the firm had a say—or a career path—was causing high employee turnover, Todd says. The firm was holding on to only 65% of its staff.
Such stories are common at firms that see rapid growth. The people who succeed early on don’t want to delegate power or chores or spread the equity around because they were in the trenches and feel entitled. But as firms get larger, that attitude becomes less tenable. At Innovest, Todd says, that had led to a lack of direction and a lack of buy-in by employees. (Both Todd and Dominguez describe themselves as fairly competitive, though they have a good brother-sister type relationship with each other.) “We didn’t involve anybody else in our firm,” Todd says. “It was hard for us to trust people. And it was hard for us to keep good people.” The company’s 15 or so staffers at the time, in that situation, couldn’t see a career path or vision.
The firm brought a consultant into the mix who saw the heartache. The advice was that the firm needed to “flatten” its hierarchy.
“He was trying to flatten our structure and I fought it because of my controlling nature,” Todd says. “I agreed that we would form five committees or departments and that I would not be leading them. And what happened is our firm became a lot better and our growth exploded. We empowered people. And that’s why our reputation is what it is.”
“We created a lot of buy-in and formal structures for people to give feedback,” Dominguez says. The firm’s current COO, Peter Mustian, started with the firm right out of school some 12 years ago. “He started as an analyst’s assistant, and people see how he’s come through the firm,” Todd says.
The firm now has 13 partners, though the two of them still own 68% of the firm, and Todd owns 48%.
Dominguez is “more of a manager while I’m more of the leader, more of the visionary,” Todd says, stressing that among a lot of analytical people, analysis isn’t his strong suit as much as vision and salesmanship. Knowing people is a great deal of the manager equation, he says.
“We can’t make salespeople into analysts, and we can’t make analysts into managers.” Employee retention has risen to over 90%, and the career paths are clear, Todd says.