Wednesday, January 13, 2016

Fees and Higher Cost Asset Classes in Retirement Plans

Earlier this week, I wrote about Bell v Anthem and the rampant litigation over fees in defined contribution plans. I thought I'd take this one step farther today and discuss a few related topics.

Since this post in particular is highly legal in nature and deals with a number of investment topics, I am going to reiterate that I am not an attorney and do not provide legal advice nor am I a CFA, CFP, or RIA, and I do not provide investment advice. Any of either that you glean from this piece is at your own risk and is not intended.

For the most part, the fee-related class action suits have been about failure of the plan sponsor and its committee to properly follow its own Investment Policy and to fail to use the least expensive funds available when it does. Suppose the retirement plan in question along with its committee believe that it's in the best interest of plan participants to have a truly diversified set of investment options available to them in the plan. And, by truly diversified, they have included a set of alternative investments and hedge funds. Many plans do not.

Alternative investments as a group tend to be expensive. One might argue that it takes a more unique skill set to manage them and that simple supply and demand justifies the higher fee structure. Whether that argument holds water or not is not the purpose here, but in any event, you just don't see inexpensive alternative investment funds. Hedge funds tend to be among the most expensive of all. Seen as the ultimate in risk and reward, fees are usually extraordinarily high when compared to other asset classes.

Now, we return to the ERISA requirements that a fiduciary act in the best interests of plan participants and that expenses not be more than reasonable (as an aside, I don't think the word reasonable should ever be in the statute because your idea of reasonable may incorrectly differ with my correct idea of reasonable ... just kidding).

What makes an expense reasonable? In the case of an S&P 500 index fund, we would expect the returns before subtracting out expenses to be virtually identical for two funds, and therefore would hope that the funds with expenses toward the lower end of the spectrum available for the plan would be considered reasonable. Two international real property funds, on the other hand, will not have the same returns. And, each probably only has one share class (in other words, there is not a retail and wholesale or institutional). If Fund A has been returning (over the last 10 years) 14% per year before subtracting expenses and Fund B only 11% per year before subtracting expenses, does Fund A justify a higher level of expenses?

I don't know.

Could you get sued if you offer Fund A in your plan with expenses at 3.5% rather than Fund B with expenses at 2%? Yes, you could. Would you win that suit? I don't know.

The whole concept raises an interesting question that I touched on the other day. With all of these 401(k) lawsuits, is it prudent to offer a 401(k) plan? Is it prudent to be on the Investment Committee of a 401(k) plan? Is it prudent to offer a fund lineup in a 401(k) plan over which you could get sued, but on which you have absolutely no idea on which merits or lack thereof the case would be judged?

I don't know the answer to any of those questions, but I think they are food for thought.

Three decades ago, the defined benefit plan was king and defined contribution plans were far more often thought as a supplemental means of saving. This concept makes more sense to me.

Is it time for a return? Is it time for a return if you have all of the characteristics of that 401(k) plan without the attendant litigation risk? I think maybe it is.

No comments:

Post a Comment