As I was researching for this week's exclusive interview with 401k Averages Book co-editor David Huntley (see it here: "Exclusive Interview: David Huntley Explains Fees Just One Component of Value," FiduciaryNews.com, May 19, 2015), I stumbled upon something I wrote when I first reviewed the book in 2011:
"Over the next year or so, fee disclosures will become the trending topic among 401(k) plan sponsors and fiduciaries. It will be tempting to overweight this parameter, but proper fiduciary due diligence requires one to focus on what really matters to the beneficiary. Fees may matter (and, in certain circumstances like index fund expense ratios, they will matter). However, in some cases – like overall investment returns – fees may be of lesser concern."
What strikes me is how this so clearly marries the DOL proposed Conflict-of-Interest Rule and the impact of Tibble v. Edison.
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But first, is anyone really surprised by the decision. I mean, what reasonable person would place a statute of limitations on an ongoing duty? This was a no brainer for the Supreme Court as the fact their decision was unanimous tells you.
At its most basic, Tibble v. Edison is all about fees and the appropriateness of fee disclosure. The plan service providers were left of the hook because they had no duty to disclose. The plan sponsor was the one left holding the bag because of a failure to conduct proper due diligence (which would have revealed the offending conflict-of-interest fees. Yes, this addresses the first portion of my 2011 quote, but the second half looms more important.
On the face of it, the DOL's proposed rule makes it appears that mere disclosure will insulate fiduciaries from the liability of conflict-of-interest transactions. But the DOL is quick to add that disclosure will protect the service provider only to the effect the fees are reasonable. In the case of Tibble v. Edison, the lower court has already ruled it's not reasonable for a fiduciary to select a higher cost share class of the same fund when a less expensive share class is available.
But notice the significant qualifier here. The court was only able to categorically rule the higher fee fund was unreasonable because the identical fund (i.e., the identical portfolio) was available at a lesser fee. It's hard to see a court saying, in the case of two different portfolios with two different fees, that the lower fee fund will automatically produce a lower return. There are just too many cases of higher fee funds (even in the same asset class) generating better performance than funds with lower fees.
Except for one class of funds – Index Funds. Yes, as the 2011 excerpt suggests, the focus on fees will eventually narrow itself just to the index fund genre. Funds tracking similar indexes, by definition, have identical portfolios, even when managed by different firms. Clearly, index funds charging a lower fee should perform better than index funds charging a higher fee. No amount of disclosure will remove the unreasonableness of choosing an index fund with a significantly higher fee.
So, where does this leave us? Allow me to offer a bold prediction: If the DOL proposed rule is implemented, you'll see a consolidation of the index fund industry, with expense ratios and fees converging to the lowest possible basis point. This means only the largest will survive – if that. It could be that a race to the bottom ensues that makes the offering of index funds unprofitable. Then what?
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Christopher Carosa
Chris Carosa has been writing a weekly article and monthly column for BenefitsPRO online and BenefitsPRO Magazine since 2011 and is a nationally recognized award-winning writer, researcher and speaker. He’s written seven books, including From Cradle to Retire: The Child IRA; Hey! What’s My Number? – How to Increase the Odds You Will Retire in Comfort; A Pizza The Action: Everything I Ever Learned About Business I Learned By Working in a Pizza Stand at the Erie County Fair; and the widely acclaimed 401(k) Fiduciary Solutions. Carosa is also Chief Contributing Editor of the authoritative trade journal FiduciaryNews.com and publisher of the Mendon-Honeoye Falls-Lima Sentinel, a weekly community newspaper he founded in 1989. Currently serving as President of the National Society of Newspaper Columnists and with more than 1,000 articles published in various publications, he appears regularly in the national media. A “parallel” entrepreneur, he actively runs a handful of businesses, including a small boutique investment adviser, providing hands-on experience for his writing. A trained astrophysicist, he also holds an MBA and has been designated a Certified Trust and Financial Advisor. Share your thoughts and story ideas with him through Facebook (https://www.facebook.com/christophercarosa/)and Twitter (https://twitter.com/ChrisCarosa).
