Plan sponsors, still feeling the pressure of the Department of Labor’s six-year-old fee disclosure rules and the threat of fee-related litigation, are continuing to place 401(k) fees under the microscope.

According to the “2018 Defined Contribution Trends Survey” from Callan, a consulting firm, 83% of plan sponsors calculated fees within the last year, 41% reduced their fees as a result of their fee review, and 60% are somewhat or very likely to conduct a fee study in 2018. Although reining in fees should be a good thing, it can’t be the end game and even modest fee trimming requires care.

Plan sponsors who skimp on investment management, plan administration, fiduciary services, participant education or other plan-related services may put themselves and their employees at risk.

“One of the dilemmas in the industry could be too much focus on fees and not really focus on the benefits of making the right investment decisions,” says David Musto, president of Dresher, Pa.-based Ascensus, which administers more than 43,000 401(k) plans and has over $64.8 billion in 401(k) assets under administration. “The first mistake is looking at fees without looking at performance net of fees,” he says, noting that some categories of investments lend themselves better to index investing.

Historically, fixed income, emerging markets and less liquid asset classes including real estate and commodities haven’t been indexed as readily, he says.

A second common mistake, says Musto, is looking only at fees and ignoring the benefits of greater diversification and risk control. This becomes particularly important as individuals transition to retirement and face risks related to the sequence of returns, he says. Advisors offering fiduciary services for 401(k) plans should talk to plan sponsor clients about the costs and capabilities they’re bringing, says Musto—and there’s no time to waste.

More than half of plan sponsors (53%) responding to a 2017 survey from analytics firm Cerulli Associates indicated they expected to look for a new advisor or consultant in the next 12 months. When asked why (they could select multiple reasons) 32.6% said that their advisor/consultant service costs were too high, 35.8% said they were interested in switching to an advisor or consultant who was willing to act as a fiduciary for their plans, and 37.4% said that the plan investments recommended by their current advisor had underperformed.

“You need to find a sweet spot in terms of your delivery capability,” says Musto. “So you can grow your practice without sacrificing in any way the service you’re delivering to your clients.”

Meanwhile, Musto sees a number of factors continuing to drive down 401(k) fees, including a competitive marketplace, growing client awareness about fees, sharper value propositions from advisors, an increase in the quality and volume of reporting of plan outcomes, and an industry shift toward fee-based plans and low-cost investments.

In 2017, 73% of Ascensus’s plan-sponsor clients offered passive or index investments, while only 24% did in 2011. Passive or index funds made up 38% of the total assets in the 401(k) plans Ascensus administered in 2017, whereas they represented only 7% of assets in 2011. These figures exclude target-date funds, which in 2017 represented 25% of the assets in Ascensus’s 401(k) plans, and also exclude company stock and self-directed brokerage assets.

Transparency Is King

Denver-based Russ Shipman, managing director of the retirement strategy group at Janus Henderson Investors, which manages $25 billion in defined contribution assets across more than 200 platforms, partly credits the dip in bottom-line 401(k) fees to growing investor awareness and increasing market share among the largest investment complexes participating in the space. The increase in scale among providers has created cost-saving synergies for these fund families, which they’ve passed along to investors, he says.

But from what Shipman is observing, the rate of decline in 401(k) fees is slowing. “The fairly relentless compression across the industry I wouldn’t say has completely disappeared, but it’s certainly eased,” he says. “Transparency is probably more the watchword right now” than the pressure to further reduce fees.

The most prominent and persistent trend he’s noticed is the ramping up of clean share structures—products that lack loads and 12b-1 fees (the fees associated with marketing and distribution). “There’s been an unbundling, a decoupling, a deeper understanding of fee constructs,” he says.

According to a 2017 survey of asset managers by Cerulli Associates, over 85% offer a non-revenue-sharing mutual fund share class that’s devoid of 12b-1 fees and sub-transfer agency (sub-TA) fees. The survey also found that asset managers offer a non-revenue-sharing class for nearly 80% of their investment strategies.

Like Musto, Shipman urges advisors and plan sponsors to resist the urge to make decisions based on fees alone. “Lurching to the cheapest share class—and the Department of Labor has offered guidance on this—is wrongheaded,” says Shipman. “You cannot say you’ve satisfied your fiduciary duty by going cheap.”

Instead, says Shipman, advisors and plan sponsors must also ask: What is the process of the underlying investment manager? What are the risk controls? What is the corporate structure? What other items of intangible interest are being dispensed from that organization?

“All of those things stitched together comprise what we like to point to as simply the value,” he says, adding, in that sense, fees are but one input.

Fees must be discussed client by client, says Shipman, because each plan and its participants have different objectives. A growing number of investors want to understand “not just the ins and outs of their portfolio, their asset allocation, etcetera,” he adds, “[but also] how those component parts snap together fee-wise.”

Meanwhile, industry conversations have been shifting more toward plan success and the reporting necessary to measure that success, says Mitch Cook, an institutional retirement plan consultant at Lexington, Ky.-headquartered Unified Trust Company, which manages $4.2 billion in 401(k) plan assets. Fees remain an integral part of these dialogues, he says—from benchmarking to delivering the right service model.

More plans are benchmarking fees once or even twice a year to compare costs across the industry, he says. Although using the lowest share class is often the best choice, he says, “Make sure you’re not driving fees down so low that you start losing the quality, the service and the necessary fiduciary protection to the plan sponsors.”

Plans that have a solid, defined investment process in place (as outlined in their investment policy statements) can do a better job identifying the funds they should hold and the appropriate share class, he says.

Unified Trust looks at which funds are at the top of their peer class and at alpha, beta and Sharpe ratios. It uses a proprietary scoring system and also speaks with fund managers to ensure it’s comfortable with their philosophies and approaches.

According to Cook, more plan sponsors are realizing they need to step in and pay for a portion or all the administrative expenses of their retirement program to help drive better participant outcomes. When passing 401(k) fees to participants, advisors and plan sponsors should educate them about the reasons behind any changes and why it’ll be better for them and their beneficiaries, he says.

For example, if a plan sponsor opts for customized allocations, he says, let participants know they should be better on track to retire with replacement income and that they won’t have the burden of making investment decisions on their own.

Cook reminds plan sponsors who handle administrative services in-house that they need to avoid the biggest liabilities—missing deadlines for enrolling employees in a plan and submitting contributions. For plan sponsor clients using outside providers, advisors should ensure the fees are reasonable and the services are still appropriate as their clients’ companies evolve, as pricing changes and as technology evolves to further enhance retirement programs, he says.

More Money-Saving Trends

Gene Cufone, senior vice president of retirement administration at Ascensus, which provides a plan comparison tool for record-keeping expenses, anticipates a continued trend in tiered plans. Their contracts don’t have to be renegotiated as assets grow, he says, so “it’s more of a set-it-and-forget-it arrangement.” He’s seeing increased use of tiered plans among smaller plans as they come down-market.

He’s also noticing a greater shift toward zero revenue funds. Nearly two-thirds (63%) of the assets in the 401(k) plans Ascensus administers were invested in zero revenue funds at the end of 2017, while only 37% were at the end of 2016, he says.

John Faustino, chief product and strategy officer at Fi360, a Pittsburgh-based company that provides fiduciary-related education, training and technology, has seen many existing funds cut expense ratios. He’s also seen many new funds—mutual funds, collective investment trusts (CITs) and retirement plan annuities—come out with zero revenue sharing.

“However, we would argue that it’s not the investment fees alone that advisors and plan sponsors should be looking at,” he says. Fi360’s fiduciary scoring tool, which has been around for 16 or 17 years, also looks at a number of quantitative factors including category relative performance and manager tenure.

Faustino notes that 17% of the index funds Fi360 covers fell in the bottom quartile for performance in December 2017, based on their investment returns relative to their peers, although only 8% of the index funds it covers had expense ratios in the bottom quartile. “Being in the fourth quartile is certainly a criteria that would qualify to put an investment on watch,” says Faustino.

Investment policy statements should include stringent criteria about when to put investments on watch, he says, but they shouldn’t be “overly prescriptive” about when to remove funds because it could cause excessive turnover. Instead, advisors and plan sponsors should work together to determine this, he says.

Faustino is seeing significantly rising interest for CITs in 401(k) plans because they offer low expenses and transparency and they require the trustees to be fiduciaries. He’s also seeing a lot more interest in smart beta strategies. They use a systematic approach, so investors aren’t subject to all the downs of the market, he says, but they’re not as expensive as an active manager.

He encourages advisors to compare asset allocation funds. For example, he says, suppose the average expense ratios are 0.9% for Asset Class 1 and 0.2% for Asset Class 2. Fund A, with weightings of 75% to Asset Class 1 and 25% to Asset Class 2, has a weighted average expense ratio of 0.725%. Fund B is weighted 25% to Asset Class 1 and 75% to Asset Class 2, with a weighted average expense ratio of 0.375%.

Now let’s assume the actual expense ratios are 0.65% for Fund A and 0.4% for Fund B. Although Fund A is more expensive from an absolute basis, says Faustino, it’s less expensive on a relative basis.

He also stresses the importance of understanding the demographics of 401(k) plan participants, including their ages and whether they have access to defined benefit plans. “The goal is not necessarily to have the highest-performing investment,” he says, “but it’s to have the investments that most align with the needs of the participants.”