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What CFOs need to know about DC plan investments
KEY TAKEAWAYS
  • CFOs may mistakenly favor index funds in defined contribution plan menus.
  • With the rise in fiduciary lawsuits, CFOs should scrutinize how index funds are managed.
  • Fee evaluation should include share classes, recordkeeping costs and value received.

Chief financial officers can be important partners in the fund selection and oversight of 401(k) and other defined contribution (DC) plans. As organizational stewards for mitigating financial risk and protecting capital, they tend to scrutinize two areas in particular: fees and fiduciary responsibilities.


This focus has influenced many plans to choose passive investment strategies — index funds — for plan menus in the belief they are lower cost and less liable to be challenged from a fiduciary perspective.


Before reaching this conclusion, however, it’s important to arm CFOs and other plan decision-makers with a more complete assessment. Here is an overview and some quotes from a recently released study by Capital Group and CFO.com on how passive and actively managed strategies work in DC plans.


The rise in fiduciary legal challenges does not exclude passive.


In late 2015, the Tibble v. Edison U.S. Supreme Court decision concluded that DC plan fiduciaries have an “ongoing duty to monitor” investments separate and distinct from their duty to select them. This has sparked a number of lawsuits challenging plans’ administration, fees, investment selection and types of investments.


Passive funds have not been exempt from these challenges. Fiduciaries are held to the same standard whether they select an active or passive investment strategy, and neither the courts, DOL, nor any regulatory agencies have stated a preference for passively over actively managed funds.


The sheer size of passive funds, in fact, may make them vulnerable. “There’s so much money in passively managed funds that it has become a target of the plaintiffs’ bar,” says Jason Bortz, senior vice president and senior counsel at Capital Group.


All index funds are not created equal.


As measuring tools, indexes are little more than statistical calculations. Turning indexes into actual investments, however, is quite complex. Historically, even indexes from various providers that track similar market segments have varied significantly.


Understanding the index and the nuances of managing to an index is part of the due diligence fiduciaries must perform to protect their organization and plan participants.


A key consideration for fiduciaries is how well the fund tracks against the index.


Some key questions for fiduciaries to ask when evaluating an index fund:



Fees: A question of cost or of value?


Many recent lawsuits have focused on investment and recordkeeping fees. Because passively managed funds do not require research or management expenditures, fund management fees tend to be lower. This doesn’t mean, however, that plan sponsors should reflexively default to the lowest fee funds. Whatever the asset category or investment approach, fees should be competitive, transparent and predictable.


“The duty of fiduciaries isn’t to pick the lowest or cheapest fee, it is to ensure a reasonable fee,” says Bradford P. Campbell, partner at Drinker Biddle & Reath LLP and former U.S. assistant secretary of labor for employee benefits. “You wouldn’t just pick the lowest bid from a contractor to renovate your kitchen.”


Even index funds may face scrutiny regarding fees, as there may be other less expensive options that are easily accessible and track the same index.


“S&P 500 index funds are perceived commodities, so it’s tough to rationalize one or the other except on the basis of fees,” Bortz says. Most of the lawsuits regarding fees involve small differences, sometimes as little as a few basis points.


In particular, fiduciaries have to pay attention to asset levels as they relate to the fees being charged. Many passive funds charge different prices within the same family of funds based on the size of the assets managed for a specific plan sponsor. Fee adjustments are not automatic, so fiduciaries must be proactive in monitoring costs.


Financial stewardship may lead to long-term plan success.


Managing DC plans for successful outcomes takes a dedicated team of decision-makers. 



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