The usual pattern among defined contribution (DC) plans has been that trends start at large plans and then move downstream. If that pattern holds true, more mid- and smaller-sized DC plans will be considering white label investment options if they aren’t doing so already. A recent paper from T. Rowe Price, “White Label 2.0,” offers interesting insights that can help your plan-clients improve their results with these solutions.
Motivation
Som Priestley, multiasset solutions strategist with T. Rowe Price and the paper’s author, notes that a traditional DC plan core lineup might have several individual investment strategies on it representing various asset classes and subasset classes. A white label fund can aggregate individual investment strategies into a parent asset class and simplify the plan’s lineup. For example, a sponsor could put its U.S. large-cap value and U.S. large-cap growth managers together in a U.S. large-cap, core white label fund. The resulting combinations are “often generically named,” says Priestley. “So, it will be called Company X U.S. large-cap core portfolio.”
White label funds can provide multiple benefits. They decrease the number of a platform’s investments, potentially reducing confusion among participants while still providing diversification. They also give sponsors enhanced flexibility to align their plan’s funds with either traditional or thematic strategies. According to the paper:
- “Traditional investment strategies may focus on broad asset classes, such as diversified fixed income or global equity, on sub‑asset classes or sectors, such as U.S. large‑cap or emerging market equity or incorporate multiple assets and styles.
- Thematic offerings can be designed to prioritize specific investment objectives, such as inflation protection, long‑term portfolio growth, diversified income or volatility management, as examples.”
White labeling is proving popular. Stats from the Institutional Investor Institute for Defined Contribution show that in April 2017 29%of large market plans offered white label investment options and another 23% were considering them. Among midmarket plans, 12% offered them with 20% considering.
Challenges and Solutions
T. Rowe Price examined multiple first-generation white label strategies and identified several challenges:
- Underdiversification: failure to take advantage of the full investment opportunity set;
- Overdiversification: redundant and/or suboptimal portfolios;
- Misalignment with objectives: poorly defined objectives leading to misplaced allocations and disappointing results; and
- Concentrated risk exposures: excessive or undesired portfolio risks producing losses.
Priestley suggested consultants and sponsors can start to address these challenges by adopting an enhanced white label portfolio design process that consists of three elements:
- Setting purposeful portfolio objectives;
- Ensuring comprehensive portfolio construction;
- Continuously assessing and validating.
Each element includes multiple steps. For example, one step to ensure comprehensive portfolio construction is to use multiple analytical techniques to ensure robustness and durability. The goal here is to prevent overreliance on any single set of assumptions. “We think about two principles in that regard,” Priestley explained. (We’re) stress-testing the portfolio, just making sure that it’s not dependent on any one single environment to succeed and, then, we’re also assessing the investment proposition of each underlying component both individually and within the context of the total portfolio.”
Stress testing is a valuable analytic tool to assess a portfolio’s characteristics in the white label 2.0 approach. Priestley explains that there are several ways to do that. “Typically, we think about it either as a deterministic analysis,” he explains. “[That involves] taking a portfolio, loading it into a risk system such as Barra and then setting in different potential return environments, whether that be with equities or fixed income to try to understand and project how the portfolio might perform, so, understanding what your exposure to loss might be. Scenario analysis can also be historical, so you could look at past periods that have had certain characteristics and examine how the portfolio might have done under those conditions.”
Scenario analysis is another technique to consider in the context of the portfolio’s underlying managers: How will the other manager(s) perform when one manager behaves a certain way? If manager X underperforms its benchmark during certain environments, how have the other managers done? “I think combining all of those different approaches gives you a more stress-tested idea of the portfolio and how it might do across time,” he says.
Other analytic techniques can include return-space factor analysis, holding-space factor analysis and a variety of different risk-type analyses with a goal of understanding the portfolios more fundamentally.
