The Employee Retirement Income
Security Act was enacted in September 1974. The Securities and Exchange
Commission abolished fixed-rate commissions on trading in May 1975. These were
the twin fire-starters of fee compression, and the flame continues to burn
today.
The global financial crisis ushered
in 10 years (and counting) of unconventional monetary policies in an effort to
restore confidence in our banking system and promote risk-taking. What we have
witnessed is the least respected bull market in history, in which beta
outstripped alpha in an often risk-on, risk-off environment. Investors were
rewarded for staying in the market (beta) over time, while excess returns from
active managers (alpha) have been elusive.
In a low-return and uncertain
environment, investors turn their focus to the one thing over which they have
control: investment cost.
Although the Department of Labor's
fiduciary rule was vacated this year,
its impact on the investment and retirement industry is indelible. Investors
are far more conscious of conflicts and how intermediaries and advisers are
compensated today. Business models have changed and affected compensation and
the sources of revenue.
Over the past 10 years, the DOL also
imposed a multipronged disclosure requirement to bring transparency to
retirement plan fees by requiring both a more robust Form 5500 for plan sponsors
to report to the DOL and the public, as well as a detailed disclosure by providers
of fees assessed from plan sponsors and separately from participants.
Excessive-fee class action lawsuits brought
against plan sponsors have also escalated over the past dozen years.
The litigation has had a chilling effect on the entire industry, and plan
sponsors and advisers have doubled their efforts around the fiduciary duty of
controlling plan expenses.
These forces have led plan sponsors
to: (1) replace higher-cost, actively managed alpha investments with
lower-cost, passively managed, index-tracking beta investments; (2) replace
mutual funds with collective investment trust fund structures; and (3) conduct
more fee benchmarking and issue requests for proposal to squeeze plan
administration expenses.
On the surface, retail investors and
retirement savers are big beneficiaries. Fee compression encouraged ERISA
fiduciaries and advisers to better meet their duty to control plan costs. But, like
a balloon, when you squeeze one side, the air simply moves to the other side.
For years, asset-manager-owned
record keepers were a means to an end and were used as a "loss
leader" to attract investment dollars to proprietary investments. With
increasing transparency and the imposition of fiduciary prudence, record
keepers have been forced to offer open-architecture platforms where competitor
options are also made available with full fee transparency. This
"glasnost" event turned the original asset-gathering approach on its
head. In fact, the wholesale change to indexing has limited choice,
diversification and investment ideas.
Four responses have resulted so far
from plan providers:
Pay to play
• Record keepers are assessing an
extra fee if nonproprietary funds are used, in order to level the playing field
and to discourage nonproprietary options.
• Broker-dealers have narrowed the
number of asset managers on their "approved list" and much of the
winnowing is predicated on asset managers' willingness to pay to be on the
list.
• Record keepers are creating more revenue
by imposing additional fees on other asset managers who wish to have their
products featured on their "shelves," thereby distorting the
open-architecture concept.
Leave no change on the table
• Getting into nonretirement
investment-revenue-generating services, such as financial wellness, health
savings account investing, student loan accounts and sidecar savings accounts.
• Integrating proprietary or
white-labeled managed account solutions and bundled CITs to generate additional
revenue.
Playing the long game
• Capturing IRA rollovers by
reducing or eliminating investment expenses and providing free IRA accounts
(Fidelity, for example, recently introduced zero-fee index funds).
• Free transaction cost funds and
ETFs using proprietary investments or higher fee, nonproprietary options.
• Regardless of the death of the DOL
fiduciary rule, record keepers are offering to serve as fiduciaries on both the
plan and participant level. This is a calculated bet on ultimately
"owning" the plan sponsor client by offering 3(21), 3(38) and 3(16)
services and owning plan participants by offering a robo or investment advice
that includes financial planning.
• Once locked in, providers can sell
more proprietary and higher-cost options in the plan, or in the future in IRAs.
The unintended consequences of fee
compression, enhanced transparency, voluminous reporting and the imposition of
fiduciary standards have created a "Back to the Future" environment.
The demand for low fees and high service cannot be sustained without new
revenue streams.
Fiduciaries and plan
advisers need to ask more questions and conduct more due diligence to avoid
fiduciary breaches, intentional or otherwise, to protect retirement assets.
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