Fidelity made headlines last week by announcing they were going to start charging a plan service fee on assets invested in Vanguard funds on their platform. Digging into the details, the announcement has a limited immediate impact as it only applies to prospective clients who are new to Fidelity with plan assets less than $20 million. While the immediate impact is negligible for most plans, the announcement raises an issue that is becoming more prominent within the industry.
Over the past five to ten years, the retirement plan industry has experienced significant fee compression for recordkeeping services. The compression has been driven by increased fee disclosure, a strong bull market, and increased fiduciary focus, informed in some cases by an increase in retirement plan litigation. At the same time as the market has faced fee compression, many plan fiduciaries have also changed the method by which they pay for recordkeeping services, eliminating revenue sharing subsidies and in many instances moving away from asset based pricing to per participant fees. These changes have reduced fees and limit the ability for recordkeepers to increase their fees over time as they do not benefit from the rising tide of strong capital market returns.
As recordkeeping vendors have faced fee pressure, they started to look at alternative methods to increase their revenue and margins for clients. In my experience, this trend has taken two primary forms. First, recordkeepers are more aggressive in charging for “out-of-scope” services. Second, recordkeepers are looking at avenues to monetize the relationship that they have with plan participants.
With respect to “out-of-scope” services, we have seen vendors more narrowly define the core services they are providing for the bundled fee proposed during the vendor search process. In cases where the services fall outside of the “core,” they are charging hourly, fixed, or time and materials fees to cover the additional services. While many would view this as a reasonable approach, the challenge lies in that there is no consensus on what should be included in the “core” services, and there are instances where the plan fiduciary and their vendor have a differing understanding of the “core” services.
Examples we have seen include:
- a vendor charging for changes to funds within a plan’s investment menu
- charging for fund mergers
- corporate acquisitions that result in plan mergers
- charges for preparation and fulfillment of required participant disclosures
Fidelity’s announcement fits within this categorization because their rationale for this fee is that Vanguard does not provide financial support for the recordkeeping services that Fidelity provides and they also require operational standards that increase Fidelity’s costs. In general, these costs tend to be a small percentage of a plan’s total expenses. Most frequently, these fees create minimum revenue to the recordkeeper and erode the recordkeeper’s goodwill with clients as it results in unplanned fees that are a nuisance.
While out-of-scope services are primarily a nuisance to plan sponsors that create modest revenue, the opportunity for recordkeepers to monetize the participant relationships that they maintain presents a greater opportunity for recordkeepers. Historically, this was easy because the largest recordkeeping firms were affiliated with asset management organizations (either mutual fund firms, insurance companies, or banks) that populated the investment menu with proprietary investment options that generated higher nominal revenue for their higher margin asset management groups.
Over the past two decades, the market has moved away from proprietary investment management with “open-architecture” being a standard feature of all major recordkeeping platforms. Most plan sponsors require recordkeeping vendors to provide a “clean” proposal for services that are not incumbent on using any percentage of proprietary fund options. There are still exceptions, but the likelihood of using recordkeeping services to drive growth in investment management assets under management has reduced dramatically.
With that avenue off the table, the two primary methods remaining are capturing participant rollovers and managed accounts. The capture of rollovers has long been an objective of recordkeeping vendors. They benefit by maintaining those relationships for longer and potentially consolidating the participant’s other assets on their platform. Additionally, rollovers frequently move the participant out of a low-cost, institutionally-priced recordkeeping relationship into a higher fee individual relationship where the recordkeeper is likely more successful in using proprietary investment management products. Theoretically, the higher fees for the rollover IRAs are because the vendor is providing a higher level of services, but the opportunity for abuse of this relationship is high. In fact, one of the primary objectives of the Department of Labor’s (DOL) Conflicts of Interest Rule was to combat abuses in IRA rollovers.
Managed accounts are a newer method that recordkeepers are using to try and monetize relationships. Managed account services are add-on services that enable a participant to have their account professionally managed on a discretionary basis within the plan. The services can either require participants to opt-in to the program or can be used as a default, requiring participants to opt-out if they don’t want to use it. In all cases, participants that use the ongoing discretionary portfolio management services pay an asset-based fee on their assets invested using the service. Fees can vary widely but are frequently in the 0.40% - 0.60% range. Managed accounts offer an opportunity for the higher margin revenue that used to be generated through fund management.
An evaluation of the merits and drawbacks of managed accounts is outside the scope of this blog post, but the takeaway for plan sponsors is that “fee” discussion is becoming more challenging. Diligent plan fiduciaries understand the economics of their retirement plan: who they pay, how they pay them, and how that compares to the market. As recordkeepers are becoming more aggressive in trying to find other methods to generate revenue, plan fiduciaries need to take a broader analysis of the economic relationship with their vendor to understand the scope of the fees associated with their plan. This is also important because how the recordkeeper is making money may create conflicts of interest that need to be monitored by the plan fiduciary.
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.
Any views expressed herein are those of the author(s) and not necessarily those of Multnomah Group or Multnomah Group’s clients.