Recession's Impact on Retirement Plans
ETF Strategies May Offer Better Solution for 401 (k) Plans
May 22, 2009
In a 60 minutes piece titled "401K Recession", Steve Kroft examined the recession's impact on older Americans and their 401(k) plans. Suite101 spoke with one of the pioneers in the field of active money management using Exchange Traded Funds (ETFs), Main Management LLC of San Francisco, to get some answers to the issues raised by Steve Kroft.
The failures of the existing 401(k) structure became abundantly clear in 2008 where many participants lost half of their 401(k) account balances. Clearly a different model is needed to replace the current broken system. A low fee, transparent, managed solution, such as the one offered by Main Management, warrants a closer look by plan sponsors.
Flaws with Existing 401(k) Framework
The current system calls for plan participants, many with limited financial sophistication, to pick from an array of twenty to thirty mutual funds and allocate their retirement dollars accordingly. For many this is akin to throwing darts at a board and hoping for the best.
The costs associated with mutual funds themselves are high and over time can erode up to half of plan participants’ gains over a thirty year period. As such, the fee structure is excessive and unfair to participants.
In the 60 Minutes segment, Steve Kroft identified a dozen fees that are charged and not clearly disclosed. Main Management says that the obfuscation of these fees is deliberate. This scenario exists although plan sponsors have a fiduciary duty to fully understand plan expenses and identify reasonableness of these fees. This is hard to do when one is unable to accurately identify those fees.
A Better Solution for 401 (k) Plans
Main Management LLC is part of a managed ETF solution to the current 401(k) structure that is available through Wachovia Securities. ETFs are widely recognized for their lower costs, transparency and inherent risk management properties, particularly relative to comparable mutual funds. Main Management was founded in 2002 by four former senior directors of Montgomery Securities, now part of Bank of America.
The philosophy behind the firm’s 401(k) ETF managed solution is that low fees, risk management and transparency are crucial components of overall investment returns. A testament to the firm’s successful approach is the recent placement of one of their strategies on the Informa Database’s Top Ten list of “Bull and Bear Masters,” in the All Cap Core equity category, for the trailing three years ended 3/31/09.
Reduced Cost, Transparency and Asset Allocation with ETFs
More than two thirds of mutual funds fail to beat their benchmarks on a five year basis. Using ETFs instead of mutual funds lowers the embedded fees from around 1.25% to around 0.25%. This cost savings go directly to plan participants’ bottom line. The high embedded fees within mutual funds, in addition to the unstated trading costs and slippage, are largely responsible for underperformance by mutual funds versus their benchmark indexes.
All components of this ETF managed solution are independent entities that charge their own fees that are clearly disclosed. In addition to the transparency of ETFs themselves, each participant in the solution acts as an independent fiduciary and each one discloses their own fee structure.
Several Brinson, Hood and Beebower studies have shown that over 90% of the variability in portfolio returns comes from asset allocation and less than 10% from stock selection. The vast majority of 401(k) plan participants are ill prepared to make asset allocation decisions themselves. Having the supposed “best fund managers” makes no difference if one doesn’t know when in the market cycle to select them.
Therefore, for an average 401(k) contributor, using a managed ETF solution led by an experienced money management team to make these important allocation decisions seems to make better sense.
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