By James Kwak
Apparently my former professor Ian Ayres has made a lot of people upset, at least judging by the Wall Street Journal article about him (and co-author Quinn Curtis) and indignant responses like this one from various interested parties. What Ayres and Curtis did was point out the losses that investors in 401(k) plans incur because of high fees charged at the plan level and high fees charged by individual mutual funds in those plans. The people who should be upset are the employees who are forced to invest in those plans (or lose out on the tax benefits associated with 401(k) plans.)
In their paper, Ayres and Curtis estimate the total losses caused by limited investment menus (small), fees (large), and poor investment choices (large). Those fees include both the high expense ratios and transaction costs charged by actively managed mutual funds and the plan-level administrative fees charged by 401(k) plans.
What really annoyed people in the 401(k)) industry (that is, the mutual fund companies that administer the plans and the consultants who advise companies on plans) was Ayres and Curtis’s charge that many plans are violating their fiduciary duties to plan participants by forcing them to pay these fees. Various parties connected with a plan (e.g., the named fiduciary, the administrator, the investment adviser) have fiduciary duties, which include duties of prudence (doing a reasonably diligent job) and loyalty (putting the participants’ interests first). Overpaying for investment management and administrative services would seem to constitute a breach of these duties.
The response of the industry has been one of righteous indignation and blanket assertion. For example, Drinker Biddle huffs, “In our experience, most plans are well-managed.” 401(k) plans provide different “services,” so different plan-level fees are appropriate; and high fund fees are OK because “it is commonly accepted that the use of actively managed funds is prudent.”
Just because lots of rent-seekers say so doesn’t make it so. Investment management is pretty close to a commodity business. Even if markets for illiquid assets aren’t that efficient, and even if publicly traded securities markets are a little inefficient around the edges (and I have no problem with rich people putting their excess cash into hedge funds trying to exploit those inefficiencies), paying money to gamble on fund managers is not something that companies should be encouraging their employees to do. There’s no good reason not to just provide a lineup of cheap, big index funds with low costs and low tracking error.
Plan administration is a commodity business, too. I’ve been in 401(k) or 403(b) plans at four companies (one of which changed administrators partway through), my wife has been in plans with two different administrators, and apart from fund choice I don’t recall any differences between them (and I’m pretty attentive to these things).
So yes, most plan sponsors and administrators are violating their fiduciary duties, as I argued in a paper (summary here). Not that they should stay up nights, at least for now. The courts have for the most part endorsed current behavior, probably “reasoning” that if everyone’s doing it, it must be OK. But anything Ayres and Curtis can do to draw attention to the problem of high fund fees and plan fees will help move us closer to the day when workers don’t have to pay for their companies’ poor choices.