The majority of plan sponsors and participants still pay retail and use mainly brand-name mutual funds in their defined contribution plans.
While some larger corporate plan sponsors, including The Dow Chemical Co. and Qwest Communications International Inc., have been demanding lower-priced institutional substitutes, recent studies show traditional retail mutual funds remain most popular, with sponsors choosing name recognition over cost reduction.
The trend to separate accounts, under way since 1997, has been slowed by fund families' introduction of institutionally priced mutual fund shares designed for the retirement market. While the amount of assets in institutional investment strategies in the 401(k) market grew to 30% in 1999 from 23% in 1996, assets in separate accounts and commingled funds remained relatively stable, rising to 22% of 401(k) assets from 21% during the period, according to a joint study by Strategic Insight Mutual Fund Research and Consulting LLC, New York, and NewRiver Inc., Andover, Mass.
Defined contribution plan assets in mutual funds increased to $60 billion in 2000, a slight increase from 1999, the report noted. Nearly half of defined contribution assets are invested in mutual funds.
For some plan sponsors, however, pricing might not be as important as investment choice and services, said Darlene DeRemer, managing director of NewRiver.
"As plan participants' defined contribution accounts continue to grow, some to well over $100,000, and due to more volatile markets, investors will become more concerned and protective of their nest eggs," the study contends." For most DC investors, the investment comfort generated by owning a brand-name fund far outweighs the benefits of a pooled account."
Participants also want an investment relationship with a fund company that has an established retail business so they can move their money into an individual retirement account with identical funds when they leave their jobs or retire, the study showed.
Institutionally priced vehicles are offered mainly in the larger plan market. CitiStreet, Quincy, Mass., offers plans with more than $100 million in assets institutional mutual funds and separate accounts, with further fee reductions as assets in the investment options grow, said Jim Phalen, CitiStreet's chief investment officer. Its fees for institutional instruments are significantly lower than retail mutual funds. For example, the average equity mutual fund is 100 basis points; an institutionally priced investment option is less than half that, he said.
But studies show that participants and some plan sponsors might not know what fees they are paying or understand the impact the extra cost of a retail mutual fund might have on ultimate retirement income.
Large plan sponsors say they do pay attention to fees. An extra 50 basis points in fees could reduce a participant's retirement savings by 10%, said Don Butt, vice president of defined contribution plans for Qwest, Englewood, Colo.
So Qwest's menu of core options does not even contain institutionally priced mutual funds. Participants have access to mutual funds only through the $6 billion plan's brokerage window, Mr. Butt said. Consequently, the average fee for everything is 12 basis points.
"We just pay wholesale," he said. "Institutionally priced mutual funds are still too high-priced."
In a period of lower or negative returns, more plan sponsors and participants will look at plan fees, said Avi Nachmany, director of research at Strategic Insight.
And more plan sponsors are beginning to ask hard questions about the fees they pay.
"In 1992, the majority of plan sponsors interviewed by (defined contribution market researcher) DALBAR said they had no idea what their investment fees were," said Michael Weddell, consultant with Watson Wyatt Worldwide, Bethesda, Md.
Today, more employers understand that the direct fees they are charged are a net of the profits from investments less true record-keeping fees, he said. The December 1998 information letter on fees issued by the U.S. Department of Labor did increase awareness of fees, and 10% to 20% more plan sponsors began asking Watson Wyatt for a fee benchmark, Mr. Weddell said. A fee benchmark study shows plan sponsors how the fees they are paying compare with those paid by plans of similar size and complexity.
"If you are charged zero (administrative fees), it does not necessarily mean you are getting a competitive deal," Mr. Weddell said.
However, there is much more even a large plan sponsor could do, he said, including getting additional services from their providers or having providers pay for third parties to give services. "Particularly in the larger plans, they ought to be more diligent in looking at their plans," he said. "They should look at their service provider's costs and revenue structure."
Some plan sponsors don't know what they and their participants are being charged, agreed F. William McNabb III, managing director, institutional group of The Vanguard Group Inc., Valley Forge, Pa. "Basis points are not the issue. It's what you're paying and the value you are getting."
Also, plan sponsors that hire a service provider because it offers free administration often do not realize the actual costs. "One of the competitively nagging issues is that we would go into a competition and some would have no administrative fee but using mutual funds with 12b-1 fees. Participants will not earn market returns at that fee level."
Most plan sponsors are loath to have an item on participants' statements showing a charge for marketing and administration, Mr. McNabb said. "Instead of a line-item fee of, say, $120 a year, there is an extra percent that could require participants to pay hundreds of dollars."
Prompted by the 1997 hearings on aggregate costs held by the U.S. Department of Labor, Vanguard put forth the concept of "all-in costs" as a benchmark for measuring a plan's cost-effectiveness, Mr. McNabb said. These so-called "all-in costs" include all fees for investment management, record keeping, education and service.
The industry probably will move toward a standardized disclosure of fees and itemized cost accounting, with actual charges coming through investment expenses, rather than separate administrative charges, he said.
But right now, fee structures are not standardized, said Ira Hoffman, operations manager of portfolio investments at Dow Chemical, Midland, Mich. At the same time, participants do want some name-brand funds from which to choose. Moreover, plan sponsors have fiduciary responsibility to disclose fees accurately to participants and to figure out what they are being charged.
Historically, Dow Chemical has heavily relied on institutional investment options in its $4.8 billion 401(k) plan, favoring a set of unbundled service providers, Mr. Hoffman said.
Last year, the plan moved to a mix of institutional and retail funds in its set of 16 core options and a window of 34 investments under a semibundled provider. The change was not strictly based on costs, nor was it a response to the "squeaky wheels who want a zillion funds in the plan," he said. Dow wanted more services and participant tools, and a provider that could consolidate 401(k) plans of acquired companies and position the plan for a future Dow/Union Carbide plan merger. Dow did this while maintaining similar fees.