With consumers every day becoming more fee conscious and mounting pressure from regulators and litigators, Cerulli finds that advisers “believe that lower-cost investment products translate to less business risk.”
The latest report from Cerulli Associates, “Cerulli Edge –
U.S. Monthly Product Trends Edition” for January 2017, shows nearly half of
advisers plan to increase exchange-traded fund (ETF) use in preparation for the
emerging regulatory environment.
Despite being known as a low-cost investment approach offering
access to many different investment classes and styles, ETFs comprise a tiny
piece of the total investment made annually via defined contribution (DC) plans. According
to data from Cerulli, mutual funds continue to be the most common investment
vehicle in 401(k) plans, with collective trusts a distant second. ETFs make up
just a small fraction of a percent (0.02%) of the investment vehicles used in
401(k)s.
One reason ETFs have failed to catch on in the DC market is
their intraday trading is still incompatible with many defined contribution plan
recordkeeping systems, which were built to accommodate mutual funds, or similar
investment vehicles. Mutual funds trade once per day and are pooled along with
other investors’ trades. ETFs can be traded intraday, have fractional shares
and, therefore, are more liquid.
Even facing this hurdle, with consumers every day becoming more fee conscious
and mounting
pressure from regulators and litigators, Cerulli finds that advisers “believe that lower-cost investment
products translate to less business risk.”
“As a result, 45% of advisers
plan to increase ETF use and 32% plan to increase allocations to passive
investment products in preparation for a new regulatory environment,” Cerulli
reports. “The shift to passive reached a new plateau during 2016, witnessing
flows of more than $500 billion.”
NEXT: Asset flows for 2016
Cerulli’s research suggests these
inflows “come at the expense of massive outflows from active funds—totaling
$310 billion.” Overall mutual fund assets experienced “modest growth” in 2016,
increasing roughly 6.0% to $12.5 trillion.
“Annual flows were net negative,
losing $90.8 billion,” Cerulli reports. “ETFs displayed another successful year
in 2016, as assets jumped 3.4% in November and another 3.5% in December,
contributing to a total growth rate of 20%. Flows were a major component, as
the vehicle amassed $287.3 billion during 2016.”
Seeking guidance from advisers as they go, Cerulli finds some
institutional investors are “beginning to question their portfolios' passive
equity beta exposures after an extended period of upward momentum from larger
stocks that drive the overall markets as well as relatively low equity market
volatility.” This will be an important trend to follow in 2017 and beyond, Cerulli
concludes.
More information on obtaining Cerulli Associates research is
here.
Fiduciaries of the internal JPMorgan Chase 401(k) plan are
facing a proposed class-action suit, brought by an employee who argues the
retirement plan’s fees were not properly controlled and that conflicts of
interest damaged net-of-fee performance.
The suit, filed in United States District Court for the Southern
District of New York, names as defendants JPMorgan Chase Bank, as well as the
company’s board, various benefit committee members, human resources executives
and others.
The complaint echoes allegations that are by now very familiar to retirement plan industry professionals: “Plan’s
fiduciaries breached their duties of loyalty and prudence to the plan and its
participants by failing to utilize an established systematic review of the
investment options in its portfolio to evaluate them for both performance and
cost, regardless of affiliation to JPMorgan Chase … This failure to adequately
review the investment portfolio of the plan led thousands of plan participants
to pay higher than necessary fees for both proprietary investment options and
certain other options for years.”
In no uncertain terms the lawsuit alleges “blatant
self-dealing” that occurred when fiduciaries “allowed higher than necessary
fees to continue to be paid on their own proprietary options.” Again like a
long list of other proposed class action suits filed in recent months and
years, participants say the large size of the plan, valued between $14.64
billion and $20.94 billion during the class period, should have been enough to allow
plan fiduciaries to negotiate fees down to levels near the lowest available in the
market—regardless of whether a proprietary or outside provider was utilized.
The specific charges include a failure to adequately review
the investment portfolio of the plan to ensure that each investment option was
prudent, both in cost and performance and without regard to the option’s affiliation
with JPMorgan Chase. Plaintiffs also want an accounting of why the plan continued
to retain proprietary mutual funds, from the bank and its affiliated companies,
within the plan “despite the availability of nearly identical lower cost and
better performing investment options.”
Finally, participants accuse plan fiduciaries of “failing to
affect a reduction in fees on 20 different investment options at an earlier
date, most of them proprietary funds; and failing to offer commingled accounts,
separate accounts, or collective trusts in lieu of the proprietary mutual funds
in the plan, despite their far lower fees.”
NEXT: Details from
the complaint
The lead plaintiff in the challenge is a resident of
Plainfield, Illinois. Plaintiff is a current participant of the plan; and while
a participant she invested in the a proprietary JPMorgan target-date 2020 fund.
According to the text of the complaint, through her investment in this target-date
fund—which itself is made up of other mutual funds—plaintiff was also invested
in BlackRock index funds offered within the plan.
Harkening to some of the discussion around timeliness of
claims filed under ERISA coming out of the now-famous Tibble vs. Edison challenge argued before
the U.S. Supreme Court, the plaintiff suggests she “did not have knowledge of
all material facts (including, among other things, the cost of the investments
in the plan relative to alternative investments that were available to the plan
but not offered by the plan) necessary to understand that defendants breached
their fiduciary duties and engaged in other unlawful conduct in violation of
ERISA, until shortly before this suit was filed … Further, plaintiff did not
have and does not have actual knowledge of the specifics of defendants’
decision-making processes with respect to the plan, including defendants’
processes for selecting, monitoring, and removing plan investments, because
this information is solely within the possession of defendants prior to
discovery.”
A significant portion of the challenge is spent enumerating by
name a list of individual defendants across JP Morgan executive leadership and
within the HR and benefits staff. Important to note, both named fiduciaries and
de facto fiduciaries with discretionary authority with respect to the
management of the plan and its assets are called out by name. There is also an
exploration of the design of the plan, which includes some seemingly well-crafted
and even somewhat generous features when compared with industry benchmarks on factors
beyond the investment fees specifically being challenged.
As the text of the complaint lays out, “Eligible employees
are automatically enrolled 31 days following their eligibility date at a rate
of 3% of ongoing compensation, defined as the base salary or regular pay of the
employee, unless they specifically opt out or elect to enroll earlier. Each
year, the contribution rate will increase by 1% up to a total contribution rate
of 5%. The default investment choice is the appropriate TDF based on the
employee’s age and assumed retirement date of 65 … JPMorgan Chase provides
matching contributions up to 5% of ongoing compensation, following the
completion of one year of service for employees making less than $250,000 a
year … Plan participants are vested in matching contributions following three
years of total service.”
NEXT: The funds in
question
The text of the lawsuit dives into detail of the retirement plan’s
investment menu, suggesting prudent plan fiduciaries would have moved to replace
a number of proprietary investment options with alternatives from the wider market.
For example, discussing the available mid-cap growth fund, plaintiffs
suggest the annual expense ratio was between 111 and 120 basis points, but with
waivers, the charge to plan participants was closer to 93 basis points. “However,
waivers in expenses are not guaranteed and can be revoked at any time, meaning
that despite the past charges, at any time while participants were invested in
this option, charges could be increased,” the plaintiff contends. “An
investigation of actively managed alternatives within the marketplace would
have revealed that numerous actively-managed mid-cap growth mutual funds from
companies such as Vanguard, T. Rowe Price, and Prudential were available that
would have offered comparable or superior investment management services with
costs that were at least 30% lower than those charged by the [proprietary
option]. Even less expensive collective trust and separate account options were
available.”
Similar arguments are presented for the plan’s small cap
option, a core bond fund option, as well as the plan’s target-date qualified default investment alternative (QDIA),
leading the plaintiff to the conclusion that “pursuant to ERISA … defendants are
liable to restore the losses to the plan caused by their breaches of fiduciary
duties alleged.” Plaintiffs also seek the court to compel changes in plan
administration processes to avoid future issues.
Concerning the lawsuit, JPMorgan shared the following statement with PLANSPONSOR: “We have received the complaint and are reviewing it. We disagree with the central allegations and look forward to defending the claim in court.”