Trustees of DB plans routinely hire consultants to develop their plans’ investment philosophies and the strategies to implement them. The importance of asset allocation is stressed because it accounts for more than 90 percent of a portfolio’s return. Consultants also emphasize the need to select money managers who not only profess to have a well-defined investment style, but also religiously stick to it. Money managers whose style cannot be well defined are shunned and others are fired quickly when they depart from their professed approach. After all, who can implement successfully a desired asset allocation if the large-cap value manager is investing heavily in mid-cap growth stocks or if the mid-cap manager has taken major positions in small-cap stocks to make their performances look better? In fact, a major task of many consultants is dissecting the factors that determined a manager’s performance, good or bad.

1. Do the trustees feel that they can pick active managers who consistently will outperform their benchmarks? This is an important question. The financial press routinely runs articles that tout the virtue of indexing. The argument in favor of indexing goes like this: Since over long periods of time active managers as a group underperform passive benchmarks such as the S+P 500, does it make sense for plan participants to pay the much higher management fees for active management, when they can invest in index funds at a lower cost and get higher returns? 
   
   The real issue is not whether indexing is better than active management. Good active managers can outperform passive strategies. Rather, the crucial question is: Do the trustees feel that either they or their consultants can pick the funds that will be winners in the future? If they feel that their crystal balls work well, active management is the way to go. Otherwise, they better fully understand the pros and cons of both approaches and be able to justify their decisions.
   
   To complicate matters further, plan sponsors must recognize that, unlike so many DB pension plans that use separately managed accounts, they have no control over who will be a mutual fund’s manager. This decision is a strategic one made by the mutual-fund organization. Thus, when you invest in a mutual fund, you are investing in a track record that may not have been established by the current manager or management team. In fact, your fund’s manager may be the new kid on the block.
   
   
2. Do the trustees feel that the funds they have selected are appropriate for constructing portfolios? Most mutual-fund prospectuses provide managers with a wide latitude for making investment decisions. The manager’s goal is to make money for the shareholders, and how the manager does that is left up to him. This is fine if an investor says he wishes to "leave the driving to us," as is common when selecting funds for a specific purpose, such as a child’s education.
   
   But this isn’t the case for participants in self-directed retirement plans who are told that it is their responsibility to create their own asset mix from a group of pre-chosen funds. Participants in these plans can’t make meaningful asset-allocation decisions if the managers of the funds that have been selected have the latitude to invest wherever and whenever they wish.
   
   These are not theoretical issues. Fund managers often make heavy industry bets in their attempts to beat benchmarks. Others will go to large cash positions if they feel that stocks are overvalued or will purchase bonds hoping to profit from interest-rate moves. These managers might hit home runs with their decisions, but are their deviations from their professed strategies appropriate for 401(k) participants when they would not be acceptable for DB plan trustees? Furthermore, they’re doing market timing (tactical asset allocation) and the success rate of this strategy is subject to much debate.
   
   Trustees of self-directed retirement plans have a responsibility to pick funds that will not deviate from the asset classes in which they are supposed to be investing. Index funds and many actively managed funds meet this criteria, however, many other actively managed funds do not. Trustees a11 too often ignore their selection responsibility and pick well-known funds that have a lot of sizzle and high ratings, presumably to create a high comfort, level for participants. This tack is fraught with potential fiduciary problems, however.
   
   
3. Should a particular investment style be selected over another? Equity managers usually are classified as value or growth, depending on how they select the stocks that go into their portfolios. During some periods, value stocks are in vogue while at other times growth stocks shine. When a style is hot, managers of that persuasion can outperform significantly a market benchmark, such as the S+P 500 or the Russell 2000. The converse, however, is also true. Over the long haul, there is no solid evidence to suggest that one approach dominates the other or that a pure style approach will outperform a market index.
   
   Fixed-income managers also emphasize different techniques in their attempts to outperform the bond market as a whole (Lehman Brothers Aggregate Index} or specific segments of it. Trustees must become familiar with these different approaches to determine their comfort levels with them and which, if any, offer greater rewards than pure-bond indexing.