Tips for Evaluating Share Classes Within Your Plan

shutterstock_613216670_blogMy colleague, Erik Daley, recently wrote a blog on the trends we are seeing in recordkeeping fees. Every year during the second quarter, we benchmark our clients’ retirement plans to evaluate the reasonableness of the fees they are paying for recordkeeping services. During the same quarter, we help clients evaluate their choice for share classes. Does this seem odd? Why look at investment products when we are discussing recordkeeping fees? The reason we paired these two projects is that historically many plans used revenue sharing to subsidize recordkeeping fees. We could not evaluate the feasibility of re-negotiating recordkeeping fees without understanding what investment products were in the menu, the revenue sharing they paid to the recordkeeper, and the options to switch share classes to lower recordkeeping subsidies.

Over the past few years, we have seen many of our clients move to de-couple the investment products in their plan from the recordkeeping services offered by their vendor. They are eliminating the subsidies that have occurred historically and negotiating explicit recordkeeping fees from their vendor. Initially, this was done in the form of a revenue requirement and more frequently is now being done as an explicit per participant fee from the recordkeeper. With this change, they are crediting revenue sharing back to participants in the plan or using fee equalization techniques to level the revenue sharing across all investments within the menu.

The need to review share classes to understand recordkeeping fees is diminishing, but there are still good reasons to evaluate the share classes within your plan to see if there are ways to lower participants’ costs. With that in mind, here are a few tips for you.

Evaluate Share Classes At Least Annually

Plan fiduciaries should have a formal process to evaluate the share classes they have selected for the investment products in their menu at least annually. Share class selection is not a “set it and forget it” decision. It can change over time based on the fee model used by the plan’s recordkeeper, the growth of plan assets, or the launch of new products from investment managers. Decisions made a few years ago may be out of date based on any number of changes, prompted either by decisions of the fiduciaries or external factors.

With share class changes occurring all the time, it can be hard not to get into a habit of chasing your tail, creating frequent fund changes and dominating the time and attention of the fiduciaries. In our experience, creating a formalized annual process strikes the right balance between proactively managing share class decisions while not getting bogged down in a constant rotation of investment products.

Evaluate Share Classes Any Time Investment Changes Are Made

While we recommend a formalized, annual share class review process, we also know that fund changes occur for other reasons throughout the year. The fiduciaries may choose to add, replace, or remove a fund to the investment menu for any number of reasons. With the participant fee disclosure rules, any time a fund change occurs plan sponsors have to communicate the change to participants and provide an updated fee disclosure document. Because of the increased administrative burdens for making fund changes, we find that clients like to group fund changes into fewer, less frequent batches.

As a result, if the plan fiduciaries are electing to make a change in the investment menu, they should also look to see whether any share class changes can be bundled with the fund change. Batching of multiple fund changes into a single process simplifies the participant communications and can save the plan money if the recordkeeping vendor charges for fund changes or the delivery of participant disclosures.

Don’t Look Just at Share Classes

While you should consider whether the current funds’ offer any different, lower share class options, you should not limit your review to just alternate share classes. Specifically, you should also consider three other alternatives that may be available.

Alternative Index Provider – Most clients have passively-managed index funds in their investment menu. These funds are designed to track a benchmark index at a low cost. Their value is not based on the expertise or skill of an active manager, and they are therefore more commoditized than actively managed mutual funds. As a result, index funds have experienced significant downward pricing pressure over the past decade. You may be able to find a similar index fund option from another provider for less than what your participants are paying today.

Institutional Version of Strategy – Some investment managers have responded to the interest in zero revenue sharing, institutionally-priced investment options by launching new institutional funds of the same strategy. These products use the same portfolio management and research team and follow the same investment process but are not structured as an alternate share class to the existing fund you may use. As a result, these products may not show up in your “share class” evaluation, but they may be a viable option for your plan, offering a less expensive version of the same strategy for your participants.

Collective Investment Trust (CIT) – The investment managers utilized within your investment menu may also offer their strategies in a CIT investment vehicle. These are not registered mutual fund products; instead, they are pooled investment accounts generally available only to institutional investors and are maintained by a bank or trust company. There is less public data available on CIT investments, so a cursory review of alternative share classes may not make you aware of CIT alternatives available. Additionally, not all plan types can invest in these vehicles. 403(b) plans are prohibited from investing in CITs so are not an option for consideration.

Include Your Recordkeeper in the Evaluation

If you are working with an experienced investment consultant, they should be leading this process for your committee. If you are doing it yourself, you should create an internal process. Either way, you should include your recordkeeping vendor in the evaluation process. Your recordkeeper can help you understand what options are available on their investment platform and which share class provides the “best deal” based on the fund’s expense ratio and the revenue sharing agreement that the recordkeeper has negotiated with the investment management firm. Some investment management firms pay standardized revenue sharing to all recordkeepers, but other firms have revenue sharing agreements that vary by recordkeeper for the same fund and share class. Most recordkeepers do not want to publicize their revenue sharing agreements with the investment managers, so the data is not widely available. Recordkeepers will work with clients and their consultants to evaluate specific options but generally do not publish a full list of all the investment products on their menu and the revenue sharing for each product.

Ultimately, if you elect to make any changes to the investment menu, your recordkeeper will need to be involved in the process. Including them early on in your evaluation will enable you to get better information and save you time in trying to implement the change.

If you would need help reviewing your plan’s investment share classes, please feel free to contact a Multnomah Group consultant.

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.

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