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401(k) Large Cap Value

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401(k) Large Cap Value Model

Categories, Factors and Filters at a Glance

Categories	Selections
Product Type	Fund
Asset Type	Stock
Track Record	5 Years
Domestic Equity	Large Cap, Value

Criteria	K⁴ Factor
Current Return	1-Year Return +/- Category
Long Term Return	5-Year Return vs. Category Index
Representative for Category	5-Year R² to Category Index
Downside Protection	5-Year Down Market Ratio
Value Added	5-Year Information Ratio vs. Category Index
Consistency	5-Year Batting Average

Filter	Limits
Average Manager Tenure	> 3 Years
Closed to New Investors	No
Fiduciary Score	< 25

Basis for Model Design

As 401(k)s receive more and more press, financial advisors are being called upon to provide investment guidance to both plan sponsors and participants. In many regards, their goals differ from those of high net worth individuals or institutions, thus presenting a new challenge to many advisors.

Plan sponsors need assistance in selecting a diverse menu of funds that will meet the needs of their employees. With the current spotlight on fiduciary issues, sponsors are growing more sensitive to fund expenses. In addition, they may also desire a list of funds that won’t require many changes (or attention) in the coming years.

From a participant standpoint, consistency and safety are primary concerns. This isn’t surprising given that they’re deferring income for retirement and don’t want to risk losing it before having the opportunity to use it. And for many participants, this is their greatest investment as well as their most important financial decision. They’d like to make a good decision once and then stick with it.

Fortunately for the financial advisor, the plan sponsor’s and participants’ goals point in the same direction: Both seek consistent funds with decent returns. Some downside protection will reduce participants’ anxiety and the sponsor’s need to make frequent changes to the fund menu. The challenge for the advisor is to construct a list of funds that can meet these goals.

Klein Decisions’ K⁴ Fund Selection software can greatly simplify this task. For example, batting average, periodic, or rolling period returns can be selected as attributes to emphasize consistency. Down market ratio and Morningstar Risk can be used to gauge downside protection. Once the scenario is complete, filters can be used to assure a high level of fiduciary standards and to eliminate those closed to new investment. By simply changing the category elements (e.g., large cap growth to small cap growth), the same analysis can be applied to different styles and capitalizations.

Step By Step Guide

Begin by selecting “Create New Scenario” and give it the name 401(k) LCV.

On the next screen, leave “Fund” for the Product Type and “Stock” for the Asset Type. Change Track Record to “5 Years” to limit the analysis to funds with a minimum of five years’ history. Click on “Update Classes”.

On the next screen, select “Large Cap” and “Value” in the Domestic Equity section. Click on the “Update Selections” button at the bottom of the page and, when it updates, click on the “Save Selections” button at the bottom of the page.

Click “Continue” on the next two screens to bring you to the attribute selection page.

Select the following K⁴ factors to reflect the associated investment criteria:

Criteria	K⁴ Factor	Importance
Current Return	1-Year Return +/- Category	Lowest
Long Term Return	5-Year Return vs. Category Index	Medium
Representative for Category	5-year R² to Category Index	Low
Downside Protection	5-Year Down Market Ratio	High
Value Added	5-Year Information Ratio vs. Category Index	High
Consistency	5-Year Batting Average	Highest

Click “Continue” on the next page to accept the ordering for R², answer the importance questions on the next page, and the trade-off questions on the following page.

On the Results page, click on “Add” to the right of Filter Status. Hold down the control key and select “Average Manager Tenure”, “Closed to New Investors”, and “Fiduciary Score”. Click on “Add Filter”.
Enter “3” for the Minimum Manager Tenure and select “No” for Closed to New Investors. To ensure the funds meet the highest fiduciary standards, enter “25” for Maximum Fiduciary Score. Click on “Apply Filters” at the bottom of the page. This will take you back to your filtered results.

After applying the filters, the participants get the consistency and risk controls they seek while the plan sponsor gets some assurance that the funds are appropriate for use in the 401(k). The highest ranked funds will have displayed consistent long-term risk-adjusted return with a degree of current price momentum. Their R² to the benchmark index will indicate they are good representatives for their particular category and capitalization, in this case Large Cap Value. The individual or team that established this record is still at the helm and the funds have satisfied a minimum set of fiduciary standards for inclusion in a qualified retirement plan. All of the funds on the list are open to new investment and can be added to existing plans or used in establishing new ones. The funds’ long-term results suggest they should continue to be reliable holdings and can possibly remain in the plan for years, which is a benefit for the participants as well as the plan sponsor.

For instructions on how to save time by using this same scenario to build a model for other categories (e.g., Small Cap Growth), go to Tips from the Klein Bottle, “Copy and Save Time”. Once you’ve established all your scenarios for the plan, you can then use them to monitor the funds.

When it’s time to review the funds, simply copy and rename each scenario with the current date. When you open a copy, you can proceed directly to the results page and view the updated data. The update is automatic and you don’t even need to answer the questions on the Category or Preference tabs. You can now compare the current results to those in the original scenario. This is also a simple means of creating an ongoing history of your analyses to track the funds over time.

To use this same scenario for other categories (e.g., Small Cap Growth):

Click on “Back to Scenario Management” just below “Category Selection” on the top left of the page.
Locate the scenario you just created (401(k) LCV) in the current folder and click “Copy”. On the next page, rename the scenario “401(k) SCV” and click “Continue”. This will take you back to the original folder in Scenario Management.
Locate the scenario you just renamed and click on “Edit”. Click “Continue” on the next page to return to the Category Selection page.
Change the Capitalization from Large Cap to Small Cap and click “Update Selections” at the bottom of the page and, once it refreshes, click “Save Selections”.
If you are reusing the same model, there is no need to go through the Preference tab. Instead, proceed directly to the Results page to view your results.
Steps 9-12 can be repeated to create new scenarios for other categories by changing the capitalization or style in the Category Selection tab.

Once you’ve established all your scenarios for the plan, you can then use them to monitor the funds. When it’s time to review them, simply copy and rename each scenario with the current date. When you open a copy, you can proceed directly to the results page and view the updated data. The update is automatic and you don’t even need to answer the questions on the Category or Preference tabs. You can now compare the current results to those in the original scenario. This is also a simple means of creating an ongoing history of your analyses to track the funds over time.