Retirement Plan Sponsors Seek a Breakup from Mutual Funds

Sponsors of 401(k) plans and their participants are leaving mutual funds for more cost-effective structures.


The big news recently from the Investment Company Institute, the fund industry’s largest lobbying organization, was that 401(k) mutual fund fees had dropped for another year. The ICI was quick to note that most of that lowered expense is a result of participants selecting the least expensive fund options, rather than fund families reducing fees. The lowest-fee options are mostly index funds, which investors have been pouring money into as they give up more costly, actively managed vehicles.

No single factor is entirely responsible for decreased costs to 401(k) participants. Aside from the rise of index funds, it has taken hundreds of fee-related class-action lawsuits, two Department of Labor rules and numerous advances in recordkeeping technology to push down 401(k) fees. But plan costs are also coming down for a reason that has nothing to do with mutual funds themselves. The fact is, plan sponsors have been increasingly jettisoning mutual fund lineups in favor of more efficient retirement plan vehicles.

The numbers are in. Last year plans with $100 million to $200 million in assets saw the largest decrease in the use of mutual funds, according to the 2014 Defined Contribution Trend Survey of 107 plan sponsors by investment consultants Callan Associates in San Francisco. Callan also found that unitized, private label funds grew from 12.5 percent in 2012 to 14.5 percent in 2014, whereas collective trusts jumped to 60 percent from 48.3 percent.

“Plan sponsors who can afford to, and have the ability to, have been moving to nonmutual-fund vehicles,” observes Winfield Evens, director of outsourcing investment strategy at human resources consulting firm Aon Hewitt in Lincolnshire, Illinois.

It’s sad but true that many of the largest companies shifted to lower-fee 401(k) arrangements after getting hit by class-action lawsuits brought on behalf of hundreds or thousands of participants. “Thanks to class-action lawsuits related to fees, there’s been a better understanding by all parties — plan sponsors, consultants and providers — about how the economics work,” says Joshua Cohen, head of institutional defined contribution at Russell Investments in Chicago.

A class-action case related to fees for defined contributions, Tibble v. Edison International , recently went all the way to the Supreme Court. It gained prominence in May when all nine Supreme Court justices agreed that a time limit did not apply in cases in which plan sponsors select a more costly mutual fund share class when equal, if less expensive, funds were available.


The historic amount of litigation precipitated two 401(k) fee-disclosure rules promulgated by the Department of Labor in July and August 2012, the first for the employer, followed by one for the plan participants. The fee-disclosure rules have given increased scrutiny, helped to lower fees. But even with more fee disclosure, mutual fund fees and costs continue to be a complex web challenging even the defined-contribution-plan consultants whom sponsors hire. James Veneruso, a defined contribution consultant at Callan’s Chicago office, says a big part of his job “is peeling back the onion on how fees are paid. It’s following the money.”

Institutional Investor got an early peek at another consultant survey to be released later this year that indicates the number of 401(k) plans sans mutual funds is on the rise. Of 282 defined-contribution-plan sponsors, about half of which have funds in excess of $1 billion, Aon Hewitt found that more than half of the funds, which includes both Aon Hewitt clients and sponsors, are in collective trusts or separate accounts, rather than in mutual funds. Among Aon Hewitt’s own recordkeeping clients, a $370 billion business comprised mostly of funds with more than $1 billion in assets, a full 80 percent are in non-mutual-fund vehicles.

The move away from mutual funds is not so easily achieved by the smallest 401(k) plans in which participant fees are still so high that even the plain-vanilla cash account will set an employee back about 150 basis points a year. Collective, commingled and separate account routes are costly and not always suitable or desirable. In response to market demand, other options have been opening up.

Both the recordkeeping divisions of financial services firms such as Fidelity Investments and Vanguard Group, as well as their mutual fund components, have found ways to lower fees for plan participants — and keep their mutual funds in company plan lineups — says Sabrina Bailey, formerly senior investment consultant and U.S. investments defined contribution leader at the Seattle office of human resources consulting firm Mercer. Bailey’s move to Northern Trust Asset Management as global head of defined contribution was announced on August 27.

Recordkeepers have enhanced their technology to enable them to rebate the revenue share portion of a fund’s fee to participants. For example, in a fund with a 100-basis-point fee, 80 basis points used to go to the investment manager and 20 to the recordkeeper. Now, the 20 basis points are refunded to the participant, whereas the recordkeeper collects its fee on an annual per-participant basis. Plan sponsors can continue to use mutual funds and have more clarity and lower fees without the need to create the greater complexity engendered by non-mutual-fund alternatives.

Some mutual fund companies have been cooperating with the new revenue share arrangement. In situations in which they do not have the ability to rebate revenue share fees, mutual fund companies have reacted by stripping out their revenue share class. This has the added benefit of equalizing the fee disparities between actively managed and indexed mutual funds in which participants in the same plan can be paying between 50- and zero-basis-point revenue share fees. “Plan sponsors see fairness issues,” says Callan’s Veneruso.

Follow Frances Denmark on Twitter at @francesdenmark.

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