A couple of decades ago, when I used to write a fair amount about mutual funds, one of the factors that savvy advisors and mutual fund investors looked for was whether, and how much, a fund manager invested his/her own money in his/her own fund—called identity of interest. Investors took comfort in the fact that the fund manager had “skin in the game.’
So what about mutual fund company employees? Should investors, and possibly their advisors, take comfort in the fact that employees put their own money in their company’s fund(s)? And, conversely, what should investors and advisors make of the fact that a fund company’s employees are suing their employer over using company funds in their retirement plan?
These are only a few of questions being raised by a recent class action lawsuit brought by the employees of New York Life Insurance Co. against two of their company’s 401(k) plans (see Investors Are Getting Ripped Off on Index Fund Fees, Lawsuits Say, by Bloomberg’s Suzanne Woolley).
To my mind, it also raises questions about the propriety of financial services companies offering their own funds in retirement plans for their employees. On a larger scale, I wonder whether mutual fund companies’ fiduciary duty to their employees will force reductions of mutual fund fees across the board.
In the past few years, the fiduciary conversation that was initially started by the Dodd-Frank Act in 2010, and then revived most recently by the Department of Labor’s new fiduciary rules on IRAs, has, among other things, focused the attention of regulators, investors and plaintiff attorneys on the question of whether actively managed funds deliver enough excess returns to justify their expense ratios which can be ten or more times those of ETFs and index funds.
Personally, I don’t think the answer is as cut and dried as some observers seem to believe
Which has been demonstrated by the Active Share data that shows (see my In a blog written back in February, Will Active Share Be the Robo-Advisor Killer?, I reported on data by Active Share which found that the 20% of equity funds with the highest “Active Share” score outperformed their benchmark index by an average of 1.4% per year—net of all fees and costs.
More recently, that fiduciary focus has shifted to index funds and EFTs, specifically in the New York Life lawsuit. As Woolley reported, the class-action suit was brought on behalf of NYL employees who participate in either of two company 401(k) plans holding a total of $3.1 billion in assets. It seems those funds include in their investment options the NYL-owned Mainstay S&P 500 Index Fund, which charged its investors a management fee of 35 basis points. The suit goes on to point out, for comparison, that SSGA’s S&P fund charges a mere 4 basis point amd Vanguard’s index offering costs but 2 bps, concluding: “The index fund in the two NYL plans were more profitable to the company than for the plan participants.” Ouch.
While no decision has been rendered in the case, considering that NYL is a fiduciary for its employees in the plan, it’s hard to see how they are going to talk their way out of this one. But to my mind, even more problematic than the outcome of the suit will be the marketing fallout. That Mainstay Index isn’t just used in the company retirement plans: it’s sold on the retail market. Can’t you just hear the pitch of their competitors: “Even NYL’s employees think their own fund is ripping them off!”
And do you think potential customers/investors will believe any over-charging is limited to just that fund? Talk about lack of identity of interest!
With that said, the problems created by the lawsuit only get larger when we consider what NYL’s options are:
1) The company can settle the suit and continue with business as usual. Again, considering the marketing problem, good luck with that.
2) The could stop using their own funds in their 401(k)s, and use those of another fund firm. Imagine what the competition would do with that.
3) They can settle the suit and lower the fees on all the funds in their plans—including the index fund—to that of their lowest-cost competitors.
Now, you might think that what’s behind door No. 3 is the obvious solution. But have you considered the catch: if they drop their fees for their own employees, how are they going to sell the same funds with higher expenses on the retail market? Don’t you think their competition might mention that, too? That NYL employees demanded lower-cost funds? How’s that going to sound?
Finally, there’s the bigger picture. The NYL lawsuit isn’t just limited to NYL. Sure, no other fund companies were mentioned in the complaint. But they all offer employee retirement plans which make them fiduciaries for their employees. Which mean they all face exactly those same problems that NYL is facing now: how do they give their employees the lowest-cost products but charge their customers more?
The answer? Obviously (at least to me), is that they can’t. No one in the mutual fund business can. Which means that mutual fund fees across the board—both internal and retail—will become normalized. Large caps funds will cost X; small caps Y; and index funds Z. For all funds, by all companies.
That way, no one can be accused of overcharging either their employees or their investors. And fund company employees will once again have an identity of interest with their customers.