The use of mutual funds with revenue-sharing fees in retirement plans has come under fire due to a push toward 401(k) fee transparency and an increase in excessive-fee litigation, which often attacks the practice due to cost concerns.
But revenue-sharing funds can be cheaper, on a net-cost basis, than those that unbundle revenue sharing from their asset management fee, known as zero-revenue-share funds.
Some record keepers have the capability to rebate participants for revenue-sharing payments that have been made when investing in a particular fund. The net result: Those participants only end up paying the fund's asset management fee.
Rob Massa, director of retirement at Ascende Inc., an advisory firm with roughly $3.7 billion in defined-contribution plan assets, provided a recent client example involving the Invesco Diversified Dividend Fund in an R5 share class versus R6, which is the zero-revenue-share option.
The R5 class had an expense ratio of 54 bps, and the R6 class 40 bps. However, after stripping out revenue sharing, the R5 fund was 21 bps cheaper than the R6 class, at a net cost of 19 bps.
In a situation such as this, the R5, while not as transparent as the zero-revenue-share fund, is “clearly” better for participants on a cost basis, Mr. Massa said.
“Everyone is all about lowest cost and no revenue-sharing funds, but lowest cost/no revenue isn't necessarily the best for participants,” according to Shawna Christiansen, a retirement consultant at Retirement Benefits Group.
Using revenue sharing to pay for 401(k) plan services is common, albeit on the decline in recent years. Roughly 40% of defined-contribution plans use the practice to pay for plan administration, according to Callan Associates.
401(k) litigation has attacked revenue-sharing mutual funds as a sort of backdoor payment method, though, because it involves directing a portion of a mutual fund's expense, such as 12b-1 and sub-transfer-agency fees, to pay for services from providers such as record keepers and brokers.
Revenue-sharing funds often have an all-in cost that is, on its face, more expensive. But after stripping out 12b-1 and other revenue-sharing fees, which leaves nothing except the asset management cost, they can be less expensive.
While the difference often amounts to a small differential, often a few basis points, there can be instances of stark disparities, advisers said.
There's one problem: While there's been rapid development to build this technology, not all record keepers have it in place, advisers said.
“Though we tend in our firm to use zero-revenue funds and menus, more times than not it's because a lot of retirement plan providers and record keepers have difficulty crediting back the revenue sharing at the participant level on a regular basis,” said Michael Montgomery, managing principal at Montgomery Retirement Plan Advisors, which advises on roughly $1.3 billion in DC assets.
And those that have the capability differ in how they do it.
Some may do the accounting on a daily basis while some may credit revenue based on which participants are in a fund at the end of the month or quarter, Mr. Montgomery said. Further, record keepers may only extend this service to plans of a certain size.
Transamerica Retirement Solutions, for example, has a program called Fund Revenue Equalization. The revenue accounting occurs on a daily basis, and credits and debits are applied monthly to participant accounts. It's available to plans with $1 million or more in assets.
In his “perfect world,” Mr. Montgomery would select the most efficient share class. However, he ends up using zero-revenue-share lineups with most plans because it expands the universe of record keepers he is able to use with clients, and the net cost differential compared with other funds is often small anyway.
“If we made it a threshold requirement in a [request for proposals] to credit back fund revenue to the participant on a daily basis, I believe it would probably knock out over three-quarters of the respondents,” Mr. Montgomery said.
The benefits of using zero-revenue-share funds, such as greater transparency, are easily defensible to a client and in documentation, Mr. Montgomery said.
However, Mr. Massa sees a potential conflict with employers' fiduciary responsibility if they use a record keeper without rebate technology in place. A record keeper's technological inability doesn't negate the employer's responsibility to do what's correct, he said.
“If we do what the record keeper wants because that's what the record keeper can do, we have potential liability,” Mr. Massa said.
“I think anytime you're going to be told by your record keeper, if the record keeper isn't acting as a fiduciary, to do something that's not in the fiduciary's best interest, they're creating liability for you because they can't administer it, and you can't accept that as an answer,” he said.