New fee disclosure regulations could put pressure on popular asset managers that control trillions of dollars in 401(k) plans.
According to an analyst at Moody's, once plan sponsors know exactly what they're paying for, the reaction may shake up the defined contribution market.
"As people start to process and consider what it costs to run a 401(k) plan, it might make them change their choices in terms of what they offer their beneficiaries. That in turn could change the supply and demand of money management services," said Neil Epstein, vice president-senior credit officer at Moody's Investors Service.
The effective date for fee disclosure is July 1 – that's when plan providers must provide information to plan fiduciaries that explains what they're providing and all direct and indirect compensation they, or their affiliates, will receive for services, administration and investments.
Under new regulations, with high-cost providers being "less attractive" to plan sponsors and investors, there are implications that this could impact competition. At least, that was the prediction Epstein made in February, just as the Department of Labor was issuing its final rule.
Although it's too early to guess the size of impact on provider business, the change in oversight was enough to raise a red flag at Moody's. In a "Weekly Credit Outlook," a publication that offers opinions on credit market trends, Epstein declared fee disclosure regulations as being "credit negative" for major plan providers such as Fidelity, Franklin Resources, Invesco and Janus.
When BenefitsPro spoke to Epstein recently, he stuck by his initial remarks.
"As a credit rating agency, we're always concerned about credit worthiness impacted by news events — things that might be particular to a given business or things that might be on an industry-wide basis — impacting competitors and changing competitive conditions. That in turn would change the credit worthiness of somebody," Epstein said. "That particular week, I thought it was interesting that more information about the cost structure of 401(k) plans could change competitive behavior."
What exactly does credit negative mean? It's not a downgrade, but more of a warning sign for the industry that this could be a game-changing situation. The new rules will lift the veil on all fees — many that are indirect and hidden — imposed by asset managers that can impact overall savings.
The "greatest fee pressure," Epstein writes, is going to be on those firms that serve as recordkeepers that bundle asset management and other plan services together. These companies will need to disclose the extent to which products cross-subsidize one another and whether there's any conflict of interest.
If plan fiduciaries determine the fees are unreasonable or there's a conflict of interest, they may reconsider their plan offerings and shop somewhere else. Or, plan sponsors may simply opt for the cheapest investment products they can find — namely, index funds that are passively managed mutual funds, which track performance based on existing market benchmarks, as opposed to actively managed funds that try to beat the market.
What this means for traditional investment managers is that they're going to be "competing over a shrinking pie," as Epstein puts it. "With more attention focused on costs, that could further along that process of promoting the use of passive over active products."
Other costly aspects of 401(k)s include compliance and recordkeeping, which tracks things like transactions. Recordkeeping services could also include educational materials and communication.
To pay for all this plan management, providers issue several types of fees and use varying types of fee arrangements. The most prominent plan fees, according to a study from Deloitte and the Investment Company Institute, are asset-based investment related fees, which represent 74 percent of 401(k) fees and expenses.
