Twenty years ago it was hard-to-impossible to force a record keeper that also managed money to offer outside (non- prop funds) investments. The feeling is that we are now in an open architecture or unbundled world where employers sponsoring a DC (defined contribution) plan can choose from a growing number of options. The reality is somewhat different.
According to an ICI (Investment Company Institute)/Brightscope study, 67% of DC plans offer the prevailing record keeper’s proprietary investments in 2013. Not larger plans right? Wrong! 63% of DC plans with more than $1 billion offered prop funds and 79% of plans with $250 -$500 million offered them accounting for 38.6% of plan assets. One reason might be that more assets are going into a plans default option (QDIA) with target date funds (TDFs) a very popular option and many larger record keepers like Vanguard, Fidelity and T Rowe Price offer their proprietary TDF.
While there’s nothing wrong with offering a record keeper’s prop funds, the investments and the record keeping/admin services should each be judged on their own merits. According to a 2014 Pension Research Council study, only 13.7% of poorly performing prop funds were replaced by DC plans compared to 25% for others.
And then there’s the issue of revenue sharing (12(b)(1) and sub-Transfer Agency fees) imbedded in the expense ratio of funds paid for by participants that subsidize the cost of running a plan. While it’s now relatively easy to uncover revenue sharing fees for outside funds, will the record keeper be able to calculate all the benefits that the company receives from prop funds? Many offer discounts on record keeping costs for use of prop funds. JP Morgan was fined over $300 million by the SEC for selling prop funds to retail investors and most broker dealers have sold off their prop fund divisions to avoid conflicts which would be highlighted in DC plans by the DOL’s pending conflict of rule.
So is there anything legally wrong? Most DC plan advisor specialists act as fiduciaries which means they cannot get paid more for offering one investment over another. Very few if any record keepers offer investments with the exact same rev sharing and it’s hard to calculate the full benefit their receive from prop funds. But DC record keepers are not considered fiduciaries although that could change if the new DOL rule is promulgated and you might ask why fewer poor performing prop funds are removed.
Finally, the recent lawsuit against plan sponsor Insperity, an HR outsourcer, claims that their record keeper inserted a prop TDF which had poor performance and one week of history. Even low cost provider Vanguard was recently sued for high rev sharing in their funds.
Lessons? Evaluate funds, record keeping and administrators on their own merits, not because you get a better deal by bundling them. If record keeping costs are higher for non-prop funds but seem worth it in the long run, the decision is simple if a documented prudent process is followed. After all, most costs are paid for by participants.
