March 14, 2013

Alicia Munnell: Ban Actively Managed Funds From 401(k)s, IRAs

Blunt proposal springs from open-architecture argument

Why is it that every current wirehouse advisor says they’re completely open-architecture, while every former wirehouse advisor says they faced pressure to sell proprietary products?

Alicia MunnellThe New York Times ginned up controversy recently with its front-page story, “Selling the Home Brand: A Look Inside an Elite JPMorgan Unit,” which reinforced the view that wirehouses put themselves first and clients second. Now Alicia Munnell (left), director of the Center for Retirement Research at Boston College, picks up the thread.

The trouble started with The Times exposé, which detailed how advisors at JPMorgan Chase & Co. were supposedly pressured to sell the bank’s own higher-fee products. The firm responded that their advisors were permitted to sell third-party products on an open-architecture platform, but some brokers—surprise—said that they faced repercussions for doing so. 

As Munnell notes in a piece posted to MarketWatch on Wednesday, the tendency to push high-fee products goes way beyond JPMorgan Chase and was the motive behind the Department of Labor’s 2010 proposals to eliminate 12b-1 fees for anyone who gives advice to holders of individual retirement accounts (IRAs), including banks, insurance companies, RIAs and broker-dealers. 

So she calls for a “more direct approach,” one that actually bans actively managed, high-fee funds from any type of account that receives favorable treatment under the Internal Revenue Code to encourage retirement saving. 

“Many studies have shown that actively managed funds underperform index funds, even before accounting for the higher fees charged by the former,” Munnell writes. “But broker-sold mutual funds perform worst of all. One estimate is that broker-sold funds underperform average actively-managed stock funds by 23 to 255 basis points a year. Investments in tax-favored accounts should be limited to index funds.”

She goes on to argue that since the government “foregoes considerable revenue” in order to encourage retirement saving, it therefore has “a responsibility to ensure that these accounts are managed in the best interests of participants.”

“Participants have nothing to gain on average from investing in actively managed funds but end up in these investments either through ignorance (in the case of 401(k) plans) or through pressured sales (in the case of IRAs). The high fees associated with actively managed mutual funds are not associated with higher returns. They simply frustrate the policy objective of increased retirement saving.”

Banning actively managed funds from tax-favored plans would also "send a message" to those investing outside these plans that they have little to gain from active management, she concludes, giving advisors like those in the Chase Private Client program a run for their money.

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