Fees touch on many aspects of pension governance and can have a substantial negative effect on asset accumulation over time. The lack of transparency (i.e., hidden costs, commissions and undisclosed fees) has lead to a series of legal challenges in US 401k plans including class action lawsuits that claim sponsors did not exercise due diligence in monitoring fees.
In Canada the CAP Guidelines recommend that sponsors disclose the nature of any costs paid directly or indirectly by members i.e., fees paid to an investment fund manager, record keeper, investment advisor fees, and operating costs charged directly to a fund. The CAP Guidelines also recommend sponsors establish criteria and monitor the performance of all service providers, including record keepers, advisors, fund managers, or other consultants.
Fees have a significant role in a plan sponsor’s evaluation of the services rendered by service providers on behalf of the CAP members. It is noteworthy that one of the key objectives of the recent Pooled Registered Pension Plan (PRPP) proposal is to substantially lower the fees that members pay. Whether this is feasible, given the involvement of financial institutions in the PRPP is questionable. Breaking down and understanding the nature and amount of the fees paid by members is therefore prudent from a fiduciary perspective.
CAP members and sponsors often complain that the fees paid to fund managers are too high. Let’s have a closer look at some of these costs and see if this is true or just a case of not understanding the fee structure.
What fees do members pay?
CAP members generally pay fees to both the record keeper and fund manger. This is usually reported as single amount, e.g. 1%, which is applied against the market value of equities, bonds etc. (marked to market) and deducted from the members’ accounts weekly, monthly or quarterly.
In addition, the investment manager uses money directly from the fund to pay administrative costs for things like accounting, audit, reporting, and transaction costs. If these costs weren’t paid out of the fund (in short, paid for by the members) the total assets and the returns would be higher.
The fund manager administration costs are disclosed annually, on a retrospective basis, and generally range from 0.01% to 0.25%. Since these costs can vary from year to year they should be disclosed separately from the record keeper and investment management fees.
In the case of record keeping fees the entire fee may go to the record keeper. In other cases, however, a portion of the fee may be paid to an agent of record, say 0.25% – 0.45%, who provides member services on behalf of the record keeper. However, the record keeper’s fees are usually the largest component of the total fee paid by a CAP member, often representing 40% to 60% of the total.
The record keeper also generally charges plan members a higher fund management fee than the fee the record keeper actually pays the fund manager: the fund management fees members pay don’t all go to the fund manager. The CAP investors will often be charged the higher fund manager’s fee associated with the current (low) level of investment in the fund in their specific plan. At the same time, because the fund manager is managing a larger pool of funds on the record keeper’s platform, they are paid a lower fee (amount) based on the total larger pooled fund investment they are managing.
For example, if the fund manager is managing $300 million on a record keeper’s platform in a specific fund the record keeper will negotiate a lower fee, say 0.35%, to be paid to the manager based on the total $300 million (fees paid to the fund manager decrease as the size of the investment increases) whereas the member will pay the higher fund manager fee, say 0.55% based on say, $20 million invested in that fund in that plan. Fees paid to investment managers therefore are generally not the largest component of the fees paid by plan members.
In the US, the Department of labour (ERISA) now requires detailed provider-to-sponsor disclosure and sponsor-to-participant disclosure. In addition, the dollar amount of fees per $1,000 of investments must be disclosed and must be presented in a way that allows the members to compare fees between investment options. The new ERISA requirements are intended to level the playing filed for record keepers, fund managers and consultants and provide members with a better idea of what they are paying for–and reduce fees through increased competition.
Fee transparency is obviously an issue in Canada as well and it is unfortunate that more emphasis was not put on better fee disclosure in the recent proposed CAPSA revisions to the CAP Guidelines.
The CAP Guidelines recommend that plan sponsors describe and regularly monitor not only the performance of the investments but that of the service providers. From a fiduciary perspective it therefore is important that plan administrators request a breakdown of fees from the record keeper that explains the nature and amount of each component of fees.
The issue of fees is a bit more complex than it appears at first. It is therefore critical that the sponsor, administrator, and the pension committee clearly understand, monitor and disclose fee costs to CAP members.
In subsequent installments on this blog, I will cover other types of hidden fees and the issues relating to fees for different forms of life cycle funds. In addition, I will discuss ways to monitor investment manager fees and performance and how to reduce fees.