For you 401(k) plan sponsors out there - it's important for you to know the history behind the difficulties of monitoring and choosing funds in your company's 401(k) plan - and how you might make your 401(k) better.
First it's important to know that actively managed funds annual performance rankings constantly move around at random. (How they perform relative to each other.)
What is an actively managed fund? Fund managers attempt to achieve the best returns they can by actively buying and selling securities inside the fund. It is a very difficult task because emotions and news cycles dramatically move individual securities up and down no matter how well priced they look on paper. What appears to be a great company could be devastated by bad news or someone simply saying that it is overpriced. (The alternative approach is evidence-based investing in which mutual fund managers buy nearly every security available in the asset class of the fund. They may enhance returns by providing more exposure to value and small company securities which are proven statistically to perform a little better.)
When you rank the annual performance of actively managed funds in a category - from year to year their rankings bounce around like crazy from a high ranking to low, to medium, to low again. They move randomly up and down in the rankings. That's because the active managers struggle to find a winning approach and it is very challenging. Sometimes they get lucky, often they are not. The movement of the market is bad enough- and in that environment they are also constantly changing their strategy. They also have low levels of diversification (concentration) which further heightens their volatility.
So what does this mean for a 401(k) plan sponsor?
401(k) plan sponsors have a duty to monitor fund performance, and remove poorly performing funds and most funds inside 401(k) plans are actively managed. It's essentially an impossible job since these funds rankings bounce all over the map. Often they do not do much of the work. The broker or consultant suggests a list of funds. Yet they do not take any responsibility. Unless they have specifically put it in writing that they are serving as the ERISA Section 3(38) advisor, all the liability rests on the plan sponsor and their management. It is not a corporate but a personal liability.
You may remove a fund for its poor performance with no idea that it is about to have its best year ever. You may add a "hot" fund that is about to have its worst year ever.
Is there a better way to choose funds?
Studies (multiple similar studies over the years) by the most famous mutual fund evaluator - Morningstar - show that expense ratio is the most reliable indicator of future mutual fund performance. The lower the expense ratio the better the future performance. Morningstar's studies have shown that this is true across every asset class studied with a near-perfect correlation! Thank you Morningstar! We have a future performance indicator that works well! Ironically it works even better than Morningstar's own 5-star rating system!
Would you like to guess what type of investing (evidence-based vs. active management) has the lowest expense ratios as a general rule. Yep, you guessed it - evidence-based investing funds have lower expense ratios, often dramatically lower.
So all of you 401(k) plan sponsors out there pay attention. Ask yourself the question - why are you working with 401(k) providers that would recommend actively managed funds?
How did the 401(k) business get to this point?
The actively managed retail mutual funds pay 12b-1 fees - i.e. backdoor revenue streams (commissions) to financial product salespersons. They need a way to attract salesmen to use their funds over others. The institutional funds utilizing evidence-based investing typically do not pay 12b-1 fees. The financial product salespersons from big box insurance companies and brokerages who have ruled the 401(k) marketplace for years are all about back-door commissions. So they use retail mutual funds that pay back-door 12b-1 fees. Though new laws require more transparency, 401(k) plans still continue to be populated with retail actively managed funds and proprietary products like "stable value funds".
On top of that, they are not willing to take the responsibility for the funds they recommend to the plan sponsor. That responsibility and liability falls on the plan sponsor. They are also not willing to offer investment advice to the participants - only fund education. So a higher percentage of the participants make allocation mistakes compered to plans that come with investment advice.
You have a better option available to you now!
We will choose/monitor the funds for the plan sponsor including holding the liability (in writing) AND we'll use only the BEST evidence-based investing funds. By delegating the fund selection to an advisor licensed, willing and able to accept it, approximately 80% of the liability is removed.
We'll even help your employees that want help, by revealing how much to place into each fund and investing it for them at their request. We'll automatically rebalance their portfolios too.This delights the vast majority of your employees who want nothing to do with that task!
Give us a call or click on Schedule a Meeting at the bottom of your screen.