Skip to main content
MENU
Subscribe
  • Subscribe
  • Account
  • LOGIN
  • Topics
    • Alternatives
    • Consultants
    • Coronavirus
    • Courts
    • Defined Contribution
    • ESG
    • ETFs
    • Hedge Funds
    • Industry Voices
    • Investing
    • Money Management
    • Opinion
    • Partner Content
    • Pension Funds
    • Private Equity
    • Real Estate
    • Russia-Ukraine War
    • SECURE Act 2.0
    • Special Reports
    • White Papers
  • Rankings & Awards
    • 1,000 Largest Retirement Plans
    • Top-Performing Managers
    • Largest Money Managers
    • DC Money Managers
    • DC Record Keepers
    • Largest Hedge Fund Managers
    • World's Largest Retirement Funds
    • Best Places to Work in Money Management
    • Excellence & Innovation Awards
    • Eddy Awards
  • ETFs
    • Latest ETF News
    • Fund Screener
    • Education Center
    • Equities
    • Fixed Income
    • Commodities
    • Actively Managed
    • Alternatives
    • ESG Rated
  • ESG
    • Latest ESG News
    • The Institutional Investor’s Guide to ESG Investing
    • Climate Change: The Inescapable Opportunity
    • Impact Investing
    • 2022 ESG Investing Conference
    • ESG Rated ETFs
  • Defined Contribution
    • Latest DC News
    • DC Money Manager Rankings
    • DC Record Keeper Rankings
    • Innovations in DC
    • Trends in DC: Focus on Retirement Income
    • 2022 Defined Contribution East Conference
    • 2022 DC Investment Lineup Conference
  • Searches & Hires
    • Latest Searches & Hires News
    • Searches & Hires Database
    • RFPs
  • Performance Data
    • P&I Research Center
    • Earnings Tracker
    • Endowment Returns Tracker
    • Corporate Pension Contribution Tracker
    • Pension Fund Returns Tracker
    • Pension Risk Transfer Database
    • Future of Investments Research Series
    • Charts & Infographics
    • Polls
  • Careers
  • Events
    • View All Conferences
    • View All Webinars
    • 2022 Innovation Investing Conference
    • 2022 Defined Contribution East Conference
    • 2022 ESG Investing Conference
    • 2022 DC Investment Lineup Conference
    • 2022 Alternatives Investing Conference
Breadcrumb
  1. Home
  2. Print
January 23, 2006 12:00 AM

Fiduciary duty to manage fees

Long term, expenses are inversely correlated to returns

  • Tweet
  • Share
  • Share
  • Email
  • More
    Reprints Print

    By Jack Dyer

    Responsibility for accumulating retirement assets is shifting to individuals, but plan fiduciaries still make important decisions affecting participants' investment results. Fiduciaries select the vendors and investment options, and negotiate the costs of services. Fiduciaries have a duty to manage those services and costs in the best interests of their participants. Failure to do so can subject the company and the individual fiduciaries to litigation risks.

    While there are prudent steps a fiduciary can take in selecting investments, none provides fiduciaries a crystal ball. However, knowing what services cost does not require a crystal ball. Fiduciaries must ensure that participants do not overpay for investments or other services.

    Overpaying for investments is likely to directly affect participants' ultimate account balances. Generally, for every 25-basis-point decrease in net return, a participant loses between 5%BD;% and 6% of the ending account balance over a 40-year working lifetime. Using ballpark assumptions regarding contribution and matching rates, future investment returns and wage growth, the shortfall would be about $50,000 for an employee hired today at $40,000 per year. For a company with 1,000 participants, that is collectively a $50 million shortfall. The Department of Labor is increasing its review of fees paid from plan assets, and litigious participants could make writing a check for that shortfall a reality. Understanding and managing the plan's cost is a fiduciary responsibility.

    Because most plans invest in mutual funds and costs are largely related to the mutual funds' expense ratios, this analysis focuses on providing a framework for evaluating mutual fund costs. Mutual funds report investment returns net of expenses. As a result, many observers assume that the level of expenses is not relevant and net performance is the only important metric. However, in the long-term there is a direct correlation between low expenses and higher returns. This is particularly true for the most efficient investment asset classes, in which there is limited opportunity to outperform benchmarks. All other things being equal, a fund with a lower expense ratio would be expected to produce higher returns over time.

    Looking at 85 actively managed large-cap core equity funds in the Morningstar Inc. database over the 15-year period ended March 31 and ranking them by quintile in terms of annualized performance, the quintile with the highest average performance, at 12.71%, had the lowest average expense ratio, at 0.86%. In each successive quintile, average fees rose and average performance decreased, down to the lowest quintile, which had the highest average expense ratio, at 1.32%, and lowest average return, at 7.4%.

    For the 15 years, the S&P 500 stock index returned 11%, ranking in the second quintile. Only 23 of the funds evaluated outperformed the S&P 500, net of fees. The current expense ratio might not have been the fund's historical expense ratio, but the results support the intuitive notion that expenses matter. In any efficient market, we suspect expenses are inversely correlated to returns in the long run.

    So, what is the right price? Analysis of large-cap core funds found that the dollar-weighted average expense is 0.79% and that 50% of the funds evaluated have a share class available for an investment of $1 million or more that charges 1% or less. Assume a plan has $10 million invested in the large-cap core option and, based on the data in the analysis, the fiduciaries have concluded that 80 basis points is a fair price for the investment of a large-cap core portfolio. If the fee were actually 100 basis points, participants would pay $20,000 per year more than fair market. This higher fee may or may not be a problem. If the vendor, in addition to investment management, is providing services that have a value of $20,000 per year, then the fee is justified. Therefore, to determine if the extra $20,000 is reasonable, the fiduciaries must also determine the value of the non-investment services provided by the vendor.

    Of course, fiduciaries cannot look at just one fund in their lineup and conclude whether participants are paying too much or too little. Fiduciaries can do a detailed fund-by-fund analysis along these lines using this study's data and draw reasonable conclusions about a plan's aggregate costs. Also, to fully analyze the cost of a plan, fiduciaries must include all of the charges a vendor may levy, either on the plan sponsor or participants. The fund expense ratios do not necessarily represent the only costs.

    Plan fiduciaries should also note that, as assets grow, the vendor's revenue grows. In the 100 basis points scenario, if assets double, then the $20,000 difference becomes $40,000. Absent other changes, it seems unlikely the vendor's cost of providing record-keeping and other services would also double. The right cost today might not be the right one tomorrow, and fiduciaries must regularly review their plan's costs.

    For larger asset pools, mutual funds might not be the most cost-effective way to deliver investment management to plan participants. Some investment organizations are beginning to offer daily-valued commingled funds, which could be suitable investment options for defined contribution plans and offer a lower cost. It is also possible for a trustee to value a separate account daily and provide the record keeper with daily net asset values.

    Alternatively, the mutual fund industry could move away from its retail roots and begin offering truly institutionally priced share classes. Comparing just five large, well-known investment management firms' large-cap core separate account fee schedules published in the eVestment Alliance database shows an average of 17 basis points more being charged to their mutual funds. This was not a robust study, but it does suggest mutual fund directors, with a little hard negotiation, could certainly offer institutional investors cheaper investment options and still more than adequately cover their investment costs.

    Whatever the solutions, it is clear fiduciaries must take the lead in managing participant-directed plan expenses to ensure participants enjoy the living standards in retirement that their significant contributions should support.

    Jack Dyer is a vice president at Aon Investment Consulting in Somerset, N.J. His commentary is based on a more extensive analysis of expenses across multiple mutual fund strategies. The study is available upon request by e-mailing [email protected]

    Recommended for You
    Read the print edition of P&I
    Read the print edition of P&I
    How low is low? Projections say it's not low enough
    How low is low? Projections say it's not low enough
    FINRA honors Wharton's Olivia Mitchell with Ketchum Prize
    FINRA honors Wharton's Olivia Mitchell with Ketchum Prize
    OCIO, Anchor in Rough Seas
    Sponsored Content: OCIO, Anchor in Rough Seas

    Reader Poll

    May 9, 2022
    SEE MORE POLLS >
    Sponsored
    White Papers
    Are Factors a Thing of the Past?
    Q2 2022 Credit Outlook: Carry On
    Leverage does not equal risk
    Is there a mid-cap gap in your DC plan?
    Out of the Shadows: The Revolution in Shadow Accounting
    The pivotal role of fixed income markets in the ESG revolution
    View More
    Sponsored Content
    Partner Content
    The Industrialization of ESG Investment
    For institutional investors, ETFs can make meeting liquidity needs easier
    Gold: the most effective commodity investment
    2021 Investment Outlook | Investing Beyond the Pandemic: A Reset for Portfolios
    Ten ways retirement plan professionals add value to plan sponsors
    Gold: an efficient hedge
    View More
    E-MAIL NEWSLETTERS

    Sign up and get the best of News delivered straight to your email inbox, free of charge. Choose your news – we will deliver.

    Subscribe Today
    May 9, 2022 page one

    Get access to the news, research and analysis of events affecting the retirement and institutional money management businesses from a worldwide network of reporters and editors.

    Subscribe
    Connect With Us
    • RSS
    • Twitter
    • Facebook
    • LinkedIn

    Our Mission

    To consistently deliver news, research and analysis to the executives who manage the flow of funds in the institutional investment market.

    About Us

    Main Office
    685 Third Avenue
    Tenth Floor
    New York, NY 10017-4036

    Chicago Office
    130 E. Randolph St.
    Suite 3200
    Chicago, IL 60601

    Contact Us

    Careers at Crain

    About Pensions & Investments

     

    Advertising
    • Media Kit
    • P&I Content Solutions
    • P&I Careers | Post a Job
    • Reprints & Permissions
    Resources
    • Subscribe
    • Newsletters
    • FAQ
    • P&I Research Center
    • Site map
    • Staff Directory
    Legal
    • Privacy Policy
    • Terms and Conditions
    • Privacy Request
    Pensions & Investments
    Copyright © 1996-2022. Crain Communications, Inc. All Rights Reserved.
    • Topics
      • Alternatives
      • Consultants
      • Coronavirus
      • Courts
      • Defined Contribution
      • ESG
      • ETFs
      • Hedge Funds
      • Industry Voices
      • Investing
      • Money Management
      • Opinion
      • Partner Content
      • Pension Funds
      • Private Equity
      • Real Estate
      • Russia-Ukraine War
      • SECURE Act 2.0
      • Special Reports
      • White Papers
    • Rankings & Awards
      • 1,000 Largest Retirement Plans
      • Top-Performing Managers
      • Largest Money Managers
      • DC Money Managers
      • DC Record Keepers
      • Largest Hedge Fund Managers
      • World's Largest Retirement Funds
      • Best Places to Work in Money Management
      • Excellence & Innovation Awards
      • Eddy Awards
    • ETFs
      • Latest ETF News
      • Fund Screener
      • Education Center
      • Equities
      • Fixed Income
      • Commodities
      • Actively Managed
      • Alternatives
      • ESG Rated
    • ESG
      • Latest ESG News
      • The Institutional Investor’s Guide to ESG Investing
      • Climate Change: The Inescapable Opportunity
      • Impact Investing
      • 2022 ESG Investing Conference
      • ESG Rated ETFs
    • Defined Contribution
      • Latest DC News
      • DC Money Manager Rankings
      • DC Record Keeper Rankings
      • Innovations in DC
      • Trends in DC: Focus on Retirement Income
      • 2022 Defined Contribution East Conference
      • 2022 DC Investment Lineup Conference
    • Searches & Hires
      • Latest Searches & Hires News
      • Searches & Hires Database
      • RFPs
    • Performance Data
      • P&I Research Center
      • Earnings Tracker
      • Endowment Returns Tracker
      • Corporate Pension Contribution Tracker
      • Pension Fund Returns Tracker
      • Pension Risk Transfer Database
      • Future of Investments Research Series
      • Charts & Infographics
      • Polls
    • Careers
    • Events
      • View All Conferences
      • View All Webinars
      • 2022 Innovation Investing Conference
      • 2022 Defined Contribution East Conference
      • 2022 ESG Investing Conference
      • 2022 DC Investment Lineup Conference
      • 2022 Alternatives Investing Conference