DOL's 401(k) pitch strikes fear among financial advisers

Many worry that the Labor Department will create a bias favoring passively managed funds

Mar 28, 2010 @ 12:01 am

By Jessica Toonkel Marquez

The Department of Labor's unprecedented move to ask if 401(k) plan advice models should favor passively managed funds over actively managed ones has advisers alarmed that the choice of funds they can recommend to clients will be restricted.

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.


“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.”

Late last month, the Department of Labor proposed legislation aimed at cracking down on potential conflicts of interest involving brokers who provide advice to 401(k) plans. Among the agency's recommendations is allowing plans to use computer-based models created by third parties (not affiliated with the broker, or his or her firm) to help pick funds.

But the department also asked whether it should dictate which investment theories can be applied when plans use these models. In addition to asking whether historical returns should be dropped, the agency asked if it should “ascribe different levels of risk to passively and actively managed investment options.” If so, passively managed options would likely come out on top.

“Advisers don't believe that the government should have a role in dabbling over investment theories,” said Brian Graff, chief executive and executive director of the American Society of Pension Professionals and Actuaries, which has been fielding calls from concerned advisers. “Most advisers will tell you that they don't want to be handcuffed.”

If the agency does set a bias toward passively managed funds, it could mean less business for financial advisers, experts said. If a plan sponsor decides to include only index funds in its plan, the client might not feel that it needs an adviser to help choose funds, said Thomas Clark Jr., vice president of retirement plan services at Lockton Financial Advisors LLC.

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, he said.

Most advisers oppose the department's questions mainly on principle. “This makes no sense to me,” said Manny G. Erlich, managing director at The Geller Group. “They need educating.”

Any advice that doesn't take into consideration the past performance of funds isn't good advice, Mr. Francis said.

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.

Even index fund managers don't necessarily believe that the Labor Department should get involved in the active-versus-passive-management debate. “We believe index-based investments are a particularly good choice for 401(k) plans, especially as default investment options, because of their low-cost, transparent nature,” said Linda Wolohan, a spokeswoman at The Vanguard Group Inc. “That said, we believe active management is a generally accepted investment theory, and such funds with low costs and a disciplined approach have a place in participants' portfolios.”

Department of Labor officials admit they are crossing a new line by asking these questions around passive versus active management, but insist they haven't made any decisions about whether they will regulate investment theory.

“This is like "Star Trek,'” Michael L. Davis, assistant secretary of Labor, told attendees at the ASPPA 401(k) Summit in Orlando, Fla., this month. “We are going where no man has gone before.”

In comments to InvestmentNews after his presentation, Mr. Davis said the agency wants to ask the questions, because the debate around active versus passive management has been going on for years.

Industry officials, however, are planning to lobby against the agency's issuing new regulations around the issue. The ASPPA is preparing a comment letter to the department saying that it doesn't feel the latter should be involved in the debate between active and passive management.

“The appropriateness of either one is an investor-specific decision and is best made with assistance of a professional adviser,” Mr. Graff wrote in an e-mail statement.

The Investment Company Institute is still reviewing the issue and hasn't taken a position yet, said Ianthe Zabel, a spokeswoman.

But fund company officials say the industry will thrive even if the department decides to issue new regulations. “They will come out with the regulations, and we will figure out how to work around them,” said one fund company official, who asked not to be identified.

E-mail Jessica Toonkel Marquez at


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