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.”