"It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness … we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way."
The opening of Charles Dickens' "A Tale of Two Cities" is a fitting and eerie epitaph for the current state of the retail 401(k) and 403(b) market, as collective trusts fuel the winds of change and perhaps ignite a new wave of adviser lawsuits.
The stakes are getting higher for defined-contribution plans. Money is pouring into DC plans as the way that Americans (and eventually the rest of the world) save for retirement shifts from pensions and government-funded plans to participant-directed, payroll-deduction plans that roll into individual retirement accounts.
In the game of plan fees, DC consultants first beat down record keepers on their fees and then used index funds to keep costs low in an attempt to maintain their own margins.
These DC consultants — including about 1,000 plan specialists with $1 million-plus in annual revenue, 20 RIA aggregator firms and almost 100 regional super firms — are shaking up the status quo. They're forcing record keepers built to serve inexperienced plan advisers and asset managers that use traditional face-to-face wholesaling to take a sobering look at their current business models.
A storm is coming in a fight over revenue, data and power.
Collective investment trust funds, which often cost less than mutual funds, have become the new weapon for savvy firms and DC consultants to grab more revenue and the only real way to make money as a discretionary investment adviser (also known as a 3(38) fiduciary). CITs are also a way to beat up mutual fund companies that have used '40 Act funds as a way to maintain management fees. Those walls have been breached through the use of CITs as the horde of aggregators and DC consultants are able to win huge discounts.
Wilmington Trust has become the dominant retail CIT arms dealer. Rob Barnett, vice president at Wilmington Trust, said an actively managed, large-cap growth mutual fund at 70 basis points can be bought by DC consultants for less than 50 bps as a CIT. Savvy larger aggregators like NFP and RPAG are negotiating even sweeter deals by leveraging their more than $100 billion of DC assets under management to help their advisers win plans while attracting new advisers to their firms.
"We built a practice to bring large-market pricing to the small market," Mr. Barnett said.
DC consultants are using CITs, available in the past only to larger plans because they required $250 million or more for each fund, by aggregating assets from all their plans. It's hard for asset managers, especially active managers not named American Funds, to resist reducing their management fees for large pools of assets.
One group of large-market DC plan lawsuits was based on the "asleep at the wheel" concept: Plan sponsors were not using their buying power to negotiate the best deal or lowest-cost-available share class and therefore they were not fulfilling their fiduciary duties.
DC consultants that have access to lower-cost CITs but are unaware or lazy in believing R6 shares or rebated revenue-sharing deals are good enough, are ripe for "asleep at the wheel" lawsuits. And while smaller plans are not attractive to savvy litigators, DC consultants are.
Smaller plan advisers attached to a broker-dealer not only face litigation risk, their plans are vulnerable to DC consultants able to offer low-cost CITs. And while fees should not be the only reason to select a fund, discounts of 20% to 50% off the same investments will certainly get the attention of plan sponsors. For good reason.
Fred Barstein is the founder and CEO of The Retirement Advisor University and The Plan Sponsor University. He is also a contributing editor for InvestmentNews' Retirement Plan Adviser newsletter.