Most elite 401(k) plan advisers rely heavily on providers to subsidize their sales and marketing budgets. This decision has helped advisers' bottom lines in the short term — especially as the demand for service increases and fees decline — but this strategy isn't healthy, wise or sustainable in the long term.
Provider support picked up significantly over a decade ago with the emergence of defined-contribution investment-only (DCIO) providers, many of which had exited the record-keeper business. To enhance their relationships with plan advisers and gain an advantage over competitors, they created value-add programs. Allianz, for example, had a behavioral finance program led by UCLA professor Shlomo Benartzi, and Columbia Threadneedle Investments has its Retirement Learning Center. Others created white papers or made third-party services available to advisers.
DCIO budgets and margins have shrunk, partly because of the move to passive investments and target-date funds and also because of greater financial demands from record keepers and distributors. DCIOs have had to make difficult decisions limiting support only to elite plan advisers with substantial DC assets. And as elite plan advisers have gone independent and negotiated very high payout rates from their broker-dealer or registered investment adviser, they have increased reliance on DCIOs for marketing support.
But this reliance may put advisers at a disadvantage relative to competitors like Captrust that do not accept subsidies of any kind.
So what happens if DCIO support wanes or disappears? Although providers complain that advisers always have their hands out, few, if any — especially the DCIO wholesalers — would prefer to give up the leverage they enjoy and rely entirely on performance and cost.
Plan sponsors are becoming more sophisticated and concerned about fees. For example, they're beginning to understand indirect payments made by DCIOs to subsidize record-keeper costs. Given the choice, I believe plan sponsors would be more comfortable using a fiduciary adviser that does not accept DCIO subsidies, rather than an adviser that does, since those subsidies could potentially affect the adviser's investment decisions.
In addition, with declining fees putting pressure on advisers' profits, if DCIO marketing subsidies shrink or disappear, advisers will be forced either to pay for the services themselves, which may be financially untenable if they have not prepared to do so, or give up those services, which may make them uncompetitive.
So what will advisers do about it?
Most will wait it out, hoping nothing changes. Others will start weaning themselves off DCIO subsidies and looking for additional revenue from participants and plan services beyond the Triple Fs (fees, funds and fiduciary services).
Anticipating the end of provider subsidies, other advisers will try to increase their investment-related revenue by acting as a 3(38) — discretionary — investment fiduciary, or preserve their fees by cutting overall fund costs through the use of collective investment trust funds or passive investments.
But many advisers will join large aggregators or stay at wirehouses to offload noncore business management and administrative functions while enjoying greater buying power with record keepers, DCIOs and third-party, value-add providers.
Elite plan advisers may have to make some tough choices soon. And remember, not acting is a choice.