If there's one thing almost all financial experts agree on, it's that low costs favorably impact returns. In this article, Morningstar concludes: "firms with high fees are unlikely to offer above-average performance. Low-fee funds give investors the best chance of success over the long term."
A potential conflict
The clear relationship between low fees and investing "success", creates a direct conflict between brokers and their clients. Commission-based brokers can increase their compensation (for themselves and their firms) by running up trading costs and selling expensive, actively managed mutual funds. This can be good for them but bad for your returns.
The potential for widespread harm
The selection of a higher priced investment option for inclusion in a large 401(k) plan is one of the allegations (which will have to be proven at trial) in a class action complaint against Safeway Inc, its Benefits Plans Committee and its recordkeeper.
The complaint alleges a breach of fiduciary duty by Safeway and its benefit plan committee caused by the selection of target date funds managed by JP Morgan Asset Management (which is not named as defendant) in 2011 for inclusion as investment options in the Plan. Prior to that time, the Plan offered target date funds managed by Blackrock Institutional Trust Company ("Lifepath Index Funds").
The alleged wrongdoing centers around the difference in management fees charged by the Lifepath Index Funds (0.13 percent) and those charged by the JP Morgan funds (0.47-0.50 percent).
The complaint also noted the availability of target date funds from Vanguard that charged a management fee of only 0.15 percent. It alleged that, net of management fees, the Vanguard target date funds "substantially outperformed" the comparable JP Morgan funds on average for the five-year period ending 2015.
When the decision was made to replace the Lifepath funds with the JPM target date funds, JPMorgan Retirement Plan Services was the recordkeeper for the Plan. Subsequently, it was sold to Great-West Financial RPS or an affiliate, which became the new recordkeeper for the plan.
Excessive revenue-sharing payments
Finally, the Complaint asserts the JP Morgan funds kicked back 0.20 percent from its funds as a "revenue sharing payment", initially to JP Morgan Retirement Planning Services, and subsequently to Great-West, as compensation for its recordkeeping services. These revenue-sharing payments allegedly more than doubled between 2011 and 2014, while the number of participants in the Plan decreased. The Complaint asserts these payments were "far in excess of reasonable compensation" for recordkeeping services.
Fees aren't the only basis for selecting a target date fund. As the Department of Labor notes, there are "considerable differences" among the funds offered by different fund families. These differences can include investment strategy, glide paths and fees.
In order to prevail in its defense of this lawsuit, defendants will have to demonstrate both the existence of these differences (compared to the funds replaced and other lower cost options) and justification for paying a significantly higher fee for the JP Morgan funds.
This may prove to be a formidable challenge.
The views of the author are his alone. He is not affiliated with any broker, fund manager or advisory firm.
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