Fear drives behavior—who’d have thunk? New research from Boston-based global analytics firm Cerulli Associates finds that fiduciary fears support continued flows into low-cost, passive products in 401(k)s.
“There is an unfortunate misconception among plan sponsors of varying asset levels that low-cost is equivalent to low-risk from a fiduciary perspective,” Jessica Sclafani, associate director at Cerulli, said in a statement. “As such, the industry’s focus on reducing fees supports continued flows into low-cost, passive products. Asset managers feel this pressure, with half identifying increased demand for passive funds as a major challenge to winning defined contribution assets.”
Among the implications of Cerulli’s findings:
- Cost concerns are the No.1 factor for plan sponsors when making DC plan decisions. While the Department of Labor explicitly directs plan fiduciaries to “determine whether plan fees and expenses are reasonable,” many plan sponsors cite a lack of clarity regarding the definition of “reasonable” as a source of unease.
- Fiduciary liability ranks as the second-most important factor for plan sponsors when making DC plan decisions. This is undoubtedly a reflection of the nearly 40 lawsuits levied against ERISA plan sponsors during the past decade. According to Cerulli survey data, more than half of plan sponsors cite the potential for lawsuits as a “very important” factor when making DC plan decisions.
- Plan sponsors have a fiduciary responsibility to be aware of their purchasing power because the inefficiencies across investment vehicle and share classes can be material. Plan sponsors are being urged at every opportunity to ask whether they are large enough (by plan assets) to qualify for an institutional share class or alternative vehicles that carry lower costs (e.g., CITs).
“Countering the demand for passively managed funds has been a difficult task in the face of strong domestic equity returns and is not a challenge unique to the DC industry,” Sclafani adds. “What is unique to the DC industry is that demand for passive strategies is being driven by the misunderstanding of many plan fiduciaries that choosing passive is a way to offload or mitigate their fiduciary liability.”
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
It appears sponsors move to passively managed (Index/ETF) funds absolutely reduces their fiduciary liability at least relative to investment selection and performance. Who ever got sued for offering exceptionally low cost funds whose performance mirrors their benchmark?