SACRAMENTO, Calif. - The $80 billion California Public Employees' Retirement System is cutting fees by at least half for a new defined contribution plan it is sponsoring for hundreds of other government units across the state.
Officials from the retirement system and the plan's administrator - State Street Bank & Trust Co. - believe the low-cost concept used by the fund for small governments will be mirrored by other large state funds throughout the country and eventually could push down defined contribution plan fees nationally.
By leveraging its ties to its custodian and money managers on the defined benefit side - and using in-house investment staff - the system will charge each participant a flat fee of about 100 basis points for all costs, including administration and investments.
Craig Hartung, chief information officer and program development division manager for the California system, said the typical total fee for public funds is about 200 basis points per participant and can go to more than 300 basis points.
The system's pension consultant, Roz Hewsenian from Wilshire Associates, Santa Monica, Calif., said Wilshire officials never have seen fees as low as those negotiated on behalf of the California system for an institutional account.
The 457 plan is being offered to about 600,000 eligible participants in 2,300 municipalities, counties and local governments that contract with the retirement system for benefits. California state employees have an existing 457 plan.
Jake Petrosino, a California Employees' trustee who has been pushing for completion of the plan, said, "The mutual fund industry is going to have to seriously consider reducing their fees, charges and commissions to compete with (the California system's) program."
To cut costs, trustees chose, in non-competitive bidding, the pension fund's global custodian, State Street Bank, Boston, to handle plan administration, record keeping and custodianship.
Fund officials said some of the biggest cuts came in the plan administration fees. Comparisons made by the fund's staff using numbers from published prospectuses and public record proposals as of September 1993 showed State Street undercutting Aetna Life Insurance and Annuity Cos., Great West Life Insurance Co. and Hartford Insurance Co. by more than 50%.
In another fee-cutting move, the system avoided mutual funds. Instead, it will depend on its in-house investment staff; three of its external managers (Morgan Grenfell Investment Services Ltd., Brown Capital Management and Oppenheimer Capital); and State Street Bank to offer eight investment options. All options will be valued daily, a feature marketed heavily by mutual fund companies.
The options and their managers are: U.S. Treasury short-term fund, U..S. Treasury intermediate fund and Standard & Poor's 500 index fund, all by the California Employees' fund staff; stable income and balanced funds, State Street; large-capitalization equity fund, Oppenheimer; small-capitalization equity fund, Brown; and worldwide equity fund, Morgan Grenfell.
The three options offered by the retirement system's staff already are used in the 457 plan California has for state employees.
A large public fund sponsoring and providing oversight for a deferred compensation plan for small contracting agencies isn't typical, according to Randy Taylor, a vice president at State Street Bank. Mr. Taylor believes other state funds probably will follow California's lead.
If that happens, other large funds will be able to negotiate low fees or use their existing money managers to cut investment option and administration costs.
Other defined contribution plan costs can be higher because they include expense charges, flat fees and a float or delay in crediting contributions of up to 120 days a year, said Marty Walton, manager of the California system's deferred compensation program.
Some cost differences were outlined in a document from State Street Bank to the system. Using data from Morningstar Inc., Chicago, the bank cited median annual expense ratios of:
59 basis points for a U.S. Treasury intermediate bond fund, vs. 14 basis points for the retirement system;
36 basis points for an S&P 500 index fund, vs. 16 basis points for the fund;
122 basis points for a large-capitalization equity fund, vs. 17 basis points;
150 basis points for a small cap-equity fund, vs. 38 basis points; and
150 basis points for an international equity fund, vs. 20 basis points.
But probably the critical reason the system will have such low overall costs is its low administration fees, said Mr. Hartung.
For all administrative costs, State Street Bank will charge a flat fee of 65 basis points. Other companies would have charged anywhere from 80 to 155 basis points annually for the same services, according to a fund staff comparison.
(Companies cited in the comparison chart are: Aetna, Great West Life, Great Western Bank, Lincoln National Life Insurance Co., VALIC, Public Employees Benefit Services Corp. and ICMA Retirement Corp.)
William McNabb, a vice president at the low-cost mutual fund company The Vanguard Group, Valley Forge, Pa., said fees the California plan is charging are "reasonable" given the plan has no contributions as yet.
If Vanguard were taking over an established plan where the average account had $20,000, he predicted Vanguard might be able to manage the plan for 30 basis points per account, annually.
But heavy marketing costs, said Mr. McNabb, are incurred in a start-up plan. He suspects State Street Bank is looking at the California deferred compensation plan over a "longer horizon" before it will see significant return on its administrative and marketing work.
Without more detail on exact services offered and expected cash flow projections into the plan, Mr. McNabb said it is hard for him to know what Vanguard would charge to offer the same plan, but he thought it would be in the neighborhood of 100 basis points per participant.
Big pension plans can negotiate low fees, so Mr. McNabb was skeptical about using median fee numbers from Morningstar in citing the costs of an investment option.
But he added fees are hard to quantify without knowing specific details. Also, the number of active investment options a plan offers can drive up costs, he noted.
For the California retirement plan's part, one reason low costs are so important is because public and private employers have few incentives to offer employees in the current economic climate, said trustee Mr. Petrosino.
State Street Bank's Mr. Taylor said a "significant" number of government officials from other states already have called him, inquiring about the California plan. He wouldn't identify the callers.
State Street Bank already has begun marketing the plan. Mr. Taylor said 30 contracting agencies have contacted him about joining the plan.
And, Mr. Walton, the system's deferred compensation manager, said 100 agencies have contacted him about the new plan.
