SHARPE INTRODUCING SERVICE THAT WOULD BYPASS ADVISERS: NOBEL LAUREATE TO OFFER INDIVIDUALIZED PLANS VIA INTERNET TO FIRMS WITH 401(K) BENEFITS

Nobel laureate William F. Sharpe and several high-profile financial backers will launch a low-cost, Internet-based investment advisory service for the 30 million participants in defined-contribution retirement plans.

The $4.5 million computer-driven service, based in Palo Alto, Calif., and called Financial Engines Inc., is to begin in the middle of the year.

It could shake up the mutual fund industry by making specific investment recommendations with modern portfolio theory-based analytical programs widely used in defined benefit plan investing. Financial Engines will track 6,500 mutual funds and separate accounts.

It will offer forecasting that takes into account millions of scenarios, Mr. Sharpe says, and give continuing advice on specific mutual funds in personalized portfolios.

If Financial Engines ever plans to modify its program or make a pitch to financial planners, its executives don’t seem to have thought much about it so far.

“At this point, it is not on my screen. Maybe we will do something down the line,” Mr. Sharpe says.

“We don’t have any plans in the near term, but I wouldn’t rule it out,” says Jeff Maggioncalda, president and chief executive officer.

Mr. Sharpe says his service will take into account the participants’ assets outside the plan. That advice usually isn’t available to participants.

won’t sell own funds

The service will offer no mutual funds of its own and won’t give negative marks to any individual fund, but it might recommend an alternative if funds in the same plan are similar, says Mr. Sharpe.

It will offer participants optimized – highest expected returns for an expected level of risk – portfolios for their total savings, not just their 401(k) investments. In most planning software, “Risk is not put in any terms that people can evaluate,” says Mr. Sharpe.

Financial Engines plans to charge $25 to $50 per plan participant.

Its programs are being tested at three California companies: Alza Corp. in Palo Alto, Netscape Com
munications Corp. in Mountain View and Gap Inc. in San Bruno.

Describing his testing of Financial Engines, Harold Fethe, vice president of human resources at Alza, said Financial Engines “is stunning. If people understand what it is, I don’t see how it can fail to catch on.”

Alza, which has a defined contribution plan of more than $100 million, intends to subscribe to Financial Engines when the testing period ends, he says.

Fidelity Investments Strategic Advisors in Boston plans to offer something similar on the Internet by the middle of the year, said Fidelity spokeswoman Camille Lepre.

Its service will optimize portfolios, but only for assets within the defined contribution plan. Its recommendations will be limited to options in the participants’ 401(k) plan.

While some mutual funds provide consulting on participants’ total assets, that service usually costs extra, Mr. Sharpe says, and many plan participants can’t afford it.

Risk/return measurement is a cornerstone of modern portfolio theory, but the advice many participants are betting their savings on is return/return, Mr. Sharpe says.

“The idea that you can make an investment decision without even thinking about risk seems surreal to me at the least,” Mr. Sharpe says.

Other providers of defined contribution software say their computer programs are sophisticated too. Ed Cook, project manager for investor education services at the Frank Russell Co. in Tacoma, Wash., says his company’s LifePoints Retirement Planner software takes participants “by the hand” through an interview process. It helps participants determine a minimum they can live on in retirement and determines when participants are saving enough money. He says participants can model multiple investments, not just the 401(k)s.

LifePoints, however, doesn’t offer personalized optimized portfolios.

Mr. Cook says the Russell Co. offers more complex software using MPT principles, including an optimizer. It is designed for registered investment advisers, s
uch as financial planners or brokers who work with investors.

“My take on the average person on the street, which you would find in a 401(k) plan, is that he would probably need some type of assistance” when dealing with modern portfolio theory, Mr. Cook says.

Mr. Sharpe responds that MPT principles can be incorporated into software so that it is not just for “pointy-headed intellectuals.” Ordinary people do understand probabilities, he says, and are familiar with ideas like “an 80% chance of rain or 90% success rate.”

Tailored software

Defined contribution plan service provider Hewitt Associates LLC of Lincolnshire, Ill., offers retirement planning software called Futre$aver, says spokeswoman Monica Gallagher. It is tailored to fit individual 401(k) plans.

She says the software helps participants figure out how much money they will need and what tax rates they will face, and helps model different financial scenarios.

Financial Engines’ co-founders include Paul Koontz, a general partner of Foundation Capital, and C. Richard Kramlich, a general partner of New Enterprise Associates, both of Menlo Park, Calif. Both venture capital firms have invested in the service as well.

Other backers include George Roberts and Henry Kravis, partners in the leveraged buy-out firm Kohlberg, Kravis and Roberts in San Francisco and New York..

Mr. Sharpe won the Nobel Prize in 1990 for his work in financial economics.

Crain News Service