Twenty-five years ago, when a number of savvy wealth advisors, insurance agents and benefits brokers saw the potential in 401(k) plans with many acting as fiduciaries, they touted their ability to help plan sponsors lower record keeper fees. Provider fees dropped precipitously, helped in part by the 2012 408(b)(2) and 404(a)(5) regulations, a movement started years before by California congressman George Miller even making 60 Minutes in 2009 when the market collapsed, and investors saw huge declines in their 401(k) accounts.
Those actions eventually led to advisor fee decline. While some advisors' fees were egregious and others did nothing, it affected the entire industry as hungry competitors were willing to charge less. This, in turn, led to the exodus to index fees that some advisors used to prop up their fees while maintaining overall costs.
Lawsuits focused on record keeping and fund fees have only added fuel to the fire.
So why, at the same time, have the fees of wealth advisors and money managers remained relatively stable?
There are two basic reasons. First, ERISA requires plan fiduciaries to ensure that fees are reasonable. Though participating in the plan, administrators are buying on behalf of others. Second, fees always seem high in the absence of value, and most buyers have not been savvy enough to recognize value. Wealthy investors are more sophisticated and willing to pay for value, while these advisors and multifamily offices have added ancillary services.
The race to the bottom is stressing the defined contribution system with predictable results:
- Record keepers are experiencing service issues as they struggle to maintain high quality with costs increasing.
- Advisors are forced to take on more service duties, which means hiring and training people, which most are not good at.
- Advisors and providers are moving to find additional revenue sources to fuel the convergence of wealth, retirement and benefits at work, as institutional consultants have been doing through OCIO services.
- Less revenue to support advisors and providers from fund companies with the move to passive investments.
- Industry-wide consolidation.
At the same time, plan sponsors are waking up. They went from being unconsciously incompetent to consciously incompetent about five years ago and are quickly moving to being consciously competent, demanding more from their provider and advisor partners.
The cost of technology is only increasing, with record keepers constantly plugging holes in outdated and leaky systems, unable or unwilling to start fresh. Meanwhile, the price of cybersecurity is also rising, requiring armies of highly skilled professionals.
Meanwhile, the GAO is looking into industry practices of using data to cross-sell or market it to third parties, with recommendations due out next summer.
Private equity firms have spent billions buying or investing in record keepers and advisory firms, which will eventually have to pay the piper or sell at a discount. The only way to justify these prices is to drill for oil beneath the barren desert or the participants.
Though some have predicted the demise of third-party administrators through PEPs, payrolls and fintech. which can serve the explosion of small plans but with limited service, the opposite is true as more record keepers than ever work with TPAs, culminating in Fidelity finally entering the market.
TPAs are an outsourced service army that does not cost record keepers, though plans may pay more. As the expected horde of wealth advisors enters to accommodate new and smaller plans, they will need TPAs to help just as RPAs did 25 years ago. While the promise of PEPs is intriguing, so far, adoption is slower than expected, and costs are not lower due to 3(16) fiduciary services.
There is no silver bullet to solve the issues caused by the race to the bottom.
Technology and artificial intelligence can help, as well as the blockchain, which can safely unleash participant data. The need to cross-sell will only increase unless lawmakers, the courts and regulators create major hurdles. And the big will only get bigger as smaller providers, advisory firms and asset managers do not have the resources to compete, resulting in accelerated consolidation. As plan sponsors get more savvy, they may be willing to pay more for better service using their DC plan as a recruiting and retention tool.
Without fee pressure, the DC industry may have remained complacent, staying in its lane and doing what they have always done. This is why their businesses have been forced to evolve faster than wealth advisors'. Fee pressure will weed out the weak, with winners looking beyond plan fees to augment revenue and acquire, maybe at a discount.
Fred Barstein is founder and CEO of TRAU, TPSU and 401kTV.
