We ran across an interesting piece in InvestmentNews on a recent DOL trial balloon concerning passive and active funds in ERISA plans. Here's the essence of the DOL proposal:
Specifically, financial advisers point to a recent proposal in which the Labor Department asked whether computer-based advice models should take into account only the fees and expenses of a mutual fund--and not its historical returns--since they aren't guaranteed. If fees and expenses are the primary factor when recommending funds for 401(k) plans, these advisers contend, index funds will win out over actively managed funds every time.
The next paragraph is classic industry stuff:
"I was absolutely shocked that they were asking questions about whether historical performance should be a factor," said Robert L. Francis, chief operating officer at broker-dealer National Retirement Partners. "It's like saying that you should buy a Volkswagen over a Rolls Royce just because it's cheaper."
It can be difficult to choose one's metaphors on the fly, so I don't want to make too much of this, but please...that Volkswagen can get people where they need to go just fine, thankyouverymuch. The reality is that the vast majority of investors should choose the metaphorical Volkswagen over the Rolls Royce.
And then there's this deeply strange take:
A bias toward passively managed funds, leading to more 401(k) plan sponsors adding index funds to their lineups, would also have a negative impact on employee engagement in saving for retirement, said Paul R. D'Aiutolo, vice president of investments, advisory and brokerage services at UBS Institutional Consulting.
"The purpose is to keep people engaged in their plans," he said. While index funds may perform well over the long term, it's often the ups and downs of actively managed funds that keep plan participants paying attention, Mr. D'Aiutolo said.
Good grief. What a sad example of non-fiduciary thinking, as if participants' attention levels--as opposed to their future retirement security--were the objective. Engaged participation is fine, but only in the context of a sound portfolio strategy built on a foundation of best-available investment options.
[If the agency does set a bias toward passively managed funds, it] could also mean increased costs to plan sponsors because index funds offer less in revenue-sharing dollars than actively managed funds, and thus there is less money to cover record-keeping expenses, [Thomas Clark Jr., vice president of retirement plan services at Lockton Financial Advisors LLC] said.
In the new, still-emerging ERISA world, transparency is a moral and practical imperative, and by definition transparency means less revenue-sharing (preferably none). Sponsors can still pass record-keeping and other administrative expenses along to participants, but not by burying them in the utterly opaque shell game known as revenue-sharing.
In our practice, we use index funds in all asset classes where they're available. On a portfolio-weighted basis, index-based vehicles constitute 8 to 23 percent of our holdings.* For us, the most important objective is to offer fully-/globally-diversified portfolios. Though we would prefer to do that using index-based vehicles only, fund providers haven't quite gotten us there just yet.
The point of which is that we're sympathetic to the DOL's implicit instincts here, but the real world is sufficiently complex and imperfect that it's difficult to write sweeping rules that don't create a few unintended consequences. So we'd like to see the DOL tread carefully here. But the old-school, non-fiduciary thinking on display in this InvestmentNews piece reminds us that there's still enormous room for improvement in the retirement plan marketplace.
* The asset classes in which we do not use--because we do not have access to--index-based vehicles are: non-U.S. REITs, non-U.S. fixed income (developed and emerging markets), and diversified commodities. Roughly a year ago, we replaced an actively-managed T. Rowe Price fund with a new Vanguard index-based option in the non-U.S. small-cap equity category.
Jessica Toonkel Marquez, "DOL's 401(k) pitch strikes fear among financial advisers," InvestmentNews, March 28, 2010