Participants July 8, 2021

401(k) Plan Investors Tilt Further Towards Equities

Average asset allocation in equities rose to 70.2% during June, the highest level in 20 years, though the proportion of new contributions going to equities remained at 69.2%.

Reported by

The Alight Solutions 401(k) Index June 2021 update shows retirement plan investors remained light traders during the month, which featured several bouts of significant market volatility while delivering fairly strong returns.

The index shows investors were content to watch their balances rise, as there were no days of above-normal trading activity. Average net trading activity was 0.009% of 401(k) balances, down from 0.011% in May. Notably, average asset allocation in equities rose to 70.2%, the highest level in 20 years, though the proportion of new contributions going to equities remained at 69.2%.

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Looking at year-to-date trading activity, there have been only two days of above-normal trading activity, while 80 days (65%) favored trades toward equities and 44 days (35%) saw more assets moving to fixed income. According to Alight Solutions, trading inflows in June mainly went to bond funds, international funds and specialty/sector funds, whereas outflows were primarily from stable value funds, large U.S. equities and self-directed brokerage windows.

The many mid-year market updates that have been published in the past several weeks by leading asset managers and advisory firms give context to this trading activity.

In the view of Brad McMillan, managing principal and chief investment officer (CIO) at Commonwealth Financial Network, the U.S. and global economies are on a “long and winding road” toward true recovery.

“The story of 2020 was just how far from normal we could get,” he suggests. “We faced a pandemic with millions of cases and hundreds of thousands dead. Fear and government policy shut down the economy, keeping people at home and destroying businesses. Millions of people lost their jobs. From a certain perspective, it looked like a depression in the making. And it could have been. Fortunately, a combination of government stimulus programs and rapid vaccine development helped us survive economically and start to control the virus.”

McMillan says the initial recovery experienced in the early parts of 2021 has created some new problems to grapple with: those of success.

“Labor and supply shortages, plus the shadow of inflation, are calling the recovery into question,” McMillan says. “The initial bounce back has been strong, but will we get back to normal by year-end? Based on what we know today, the answer is yes.”

The outlook published by LPL Financial—put together by Ryan Detrick, chief market strategist, and Jeff Buchbinder, equity strategist—notes that the U.S. and global equity markets had strong starts this year, with the S&P 500 index up about 14% as of late June. However, Detrick and Buchbinder share some concerns that most of those gains came early in the year, and many stocks have stagnated over recent months.

“The good news is the second year of every single bull market since World War II has seen the S&P 500 climb higher,” the pair explains. “That is 12 for 12 for year two gains. The second year for this bull market started on March 23, 2021, and, so far, stocks are off to a solid start—up more than 9%. The bad news is for many of the past bull markets, year-two gains were quite muted, as stocks caught their breath from the year-one sprint. With the S&P 500 up so substantially from the March 2020 lows, we wouldn’t be surprised at all if history repeated and stocks saw choppier action in year two.”

The pair is also tracking the potentially worrying dynamic of performance consolidation.

“The S&P 500 index hit a new record high last week, but under the surface fewer stocks have been participating,” they note. “Just 15% of the stocks in the index hit a new one-month high along with the benchmark on June 24, and, for the first time since December 1999, a record closing high occurred with less than half of the stocks in the index above their 50-day moving averages. If the last few years have taught us anything, it should be that the largest technology stocks are capable of powering the S&P 500 to new highs. However, a far healthier and more sustainable trend typically sees stronger participation, like earlier in the year when new highs in the S&P 500 were commonly accompanied by 30% to 40% of the index hitting new highs as well.”

Compliance July 7, 2021

AAA Club Faces ERISA Lawsuit

The plaintiffs say prudent practices followed before a merger of retirement plans were not followed after, and they claim that when the plan switched to cheaper share class TDFs, participant accounts should have been ‘repaired.’

Reported by

Carolina Motor Club, doing business as AAA Carolinas, and subsidiaries of the American Automobile Association (AAA) club based in Charlotte, North Carolina, are accused of violating provisions of the Employee Retirement Income Security Act (ERISA), costing plan participants and beneficiaries millions of dollars.

The complaint says plan fiduciaries did this by incurring excessive fees that were paid by plan participants, failing to diversify investments, engaging in prohibited transactions with parties in interest and failing to monitor co-fiduciaries. The scope of plaintiffs and/or class members in this case is limited to members of the AAA Carolinas Savings & Investment Plan and members of the Auto Club Group Tax Deferred Savings Plan who were previously members of the AAA Carolinas plan.

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In a statement to PLANSPONSOR, AAA Carolinas said, “We are in receipt of the complaint and are in the process of reviewing. We do not have further comment at this time.”

The complaint says the case is another example of a large plan with bargaining power filling its 401(k) plan with expensive funds when identical, cheaper funds were available. However, the plaintiffs say the case “presents a unique optic.” When AAA Carolinas merged into another company, the two companies’ plans merged. The complaint includes details implying that prudent audit practices at the acquiring company, Auto Club Group, were not followed once the plans were merged. The plaintiffs note that at the time of the merger, even though the acquiring company’s plan was about 15 times larger, it had lower administrative costs than AAA Carolina’s plan.

The case alleges that the defendants “flooded the plan” with expensive, often underperforming investment options for participants to choose from until there was “a small change in direction in or around 2018.” It also alleges that the defendants never put the recordkeeping contract for the plan up for a bid to bring in more competitive offers from other service providers. The complaint says the defendants allowed the plan’s advisers and recordkeeper to take large amounts of money from the plan and its participants through fees and compensation mechanisms that were “much higher than those warranted by the amount of work these service providers were completing.”

The plaintiffs contend that revenue sharing and 12b-1 fee arrangements were possible incentives for the defendants to put higher-cost funds into the plan because they allowed service providers to charge fees to participants while the plan sponsor avoided paying fees.

The lawsuit specifically calls out a 2015 move of about half of the plan’s assets from non-target date funds (TDFs) into the JPMorgan Smart Retirement target-date series. The plaintiffs note that the defendants selected the most expensive of the available share classes. They suggest that the defendants could have easily used the free FundAnalyzer tool provided by the Financial Industry Regulatory Authority (FINRA), which would have allowed them to enter different investments into the website and get information regarding their returns and expected costs.

The complaint goes on to say that on or about January 1, 2019, the “defendants appear to have realized around this time that adding these JPMorgan funds as the default option in 2015 and seeding them with existing trust assets was an imprudent mistake that cost millions of dollars.” The defendants swapped the JPMorgan funds for an American Funds target-date series and selected the R6 share class.

The plaintiffs contend that the defendants then did nothing to “repair” the alleged damage of the prior four years on participants’ accounts. “This is in direct contradiction to the language of the IRS’ correction program, which states in part that to maintain tax-exempt status, defendants must ‘apply [a] reasonable correction method that would place affected participants in the position they would’ve been in if there were no operation plan defects.’”

The complaint also includes an analysis of fees paid to covered service providers and arguments about why they are excessive. It says that because the defendants chose to compensate their providers using asset-based revenue sharing, the service providers systematically received unjustified increases in pay. As plan assets increased from 2014 to in 2019, the recordkeeper’s compensation, which was asset-based, nearly tripled. The plaintiffs note that in that time period, the number of participants for whom the recordkeeper had to maintain records fell by 14%.

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