Nationwide is among several financial services giants that've rolled out professionally-managed 401(k) options. The roster also includes Fidelity Investments, Merrill Lynch & Co., Wachovia Corp. and American International Group Inc. In most cases, the companies partner with independent firms such as Ibbotson Associates or Morningstar that provide model portfolios based on individual participant's goals and risk profile.
For example, Wachovia provides Morningstar with a list of roughly a dozen funds from its 401(k) offerings, with some of them being its own Evergreen funds. Based on information gathered via the web or from a call center, Morningstar consultants construct individualized portfolios for each participant. Because the average-sized 401(k) portfolio is only $40,000, Morningstar president John Rekenthaler doesn't think this service cuts into the paychecks of the financial advisor community. "Financial advisors serve higher net-worth clients," he says. "We're serving the rest of the folks."
In Nationwide's case, it linked up with RIA Services Inc., a Garland, Texas company that brought together four registered investment advisory firms from around the U.S. to provide portfolio management specifically for Nationwide 401(k) plan participants. These money managers use computer-based modeling to select portfolios from among 600 funds in the Nationwide plan, including those offered by Nationwide itself. Plan sponsors appoint one of the four money managers for its participants to use if they choose to partake that option, and those who do let the managers invest their 401(k)s for them. Participation rate in the program is about 50% during its first year.
These plans don't come cheap-participants pay management fees on top of existing fund expenses. With RIA Services, the fee can reach 1.5% for an actively-managed 401(k) plan. According to the company, that's still 60% less than what wealthy clients normally pay for individually-managed accounts.
On a smaller level, The Scarborough Group has provided actively-managed 401(k) accounts to individual investors since 1988. Working independently of sponsors or participants, the Annapolis, Md.-based advisory firm manages $1.5 billion in assets from roughly 5,000 participants in more than 100 401(k) plans. "We talk individually with each plan participant to come to a consensus of who they are and where they should be from an investment perspective," says company president Michael Scarborough.
The company uses Ibbotson for basic asset-class research, then uses its own advisors to construct 401(k) portfolios for each participant. Scarborough charges a flat $365 fee, so the larger the account the less onerous the fee. The company says the retention rate has held steady at about 85%.
Now Scarborough is test marketing the licensing of its back office services to help independent advisors who are actively involved in the 401(k) business. "Larger providers are entering the business and could potentially take market share from the smaller advisers," says Scarborough. "We think our services can help the independent advisors compete in the 401(k) arena."
Despite the market turmoil from the past several years, mutual funds remain the largest asset class among 401(k) plans. According to recent figures from the Employee Benefit Research Institute, as of 2002 equity funds comprised 40% of total 401(k) account balances. But the recent onslaught of news concerning the shenanigans in the mutual fund industry regarding late trading and market timing issues might give some investors pause about the use of mutual funds in their 401(k) plans.
"To us, this is bigger than Enron because it's the trustee of your retirement fund that's allowing these things to happen," says Jeff Swantkowski, senior vice president at Kanaly Trust, a wealth management firm in Houston. "We'll have to see how these investigations play out and whether this is a big blow up for mutual funds."
Swantkowski, who advises individuals on their 401(k)s, believes the snafu could be an entrée for exchange-traded funds to play a bigger role in defined contribution plans. "Mutual funds are like insurance policies in that they're sold rather than bought," he says. "Not many people are pitching ETFs right now, which is why they're not making much inroads among plan sponsors. But as ETFs become more prevalent, I think people will appreciate their low-cost structure and perhaps think twice instead of just dumping 401(k) money into Fidelity Magellan."