Fee and Industry Shifts Mean Retirement Plan Providers Can Play Hardball

A look back at how Fidelity will charge new plan sponsor clients on its platform who choose Vanguard products makes visible the hard-nosed competition that defines the retirement plan recordkeeping and brokerage industries.

Some weeks ago, Fidelity made the announcement that it would soon begin charging a 0.05% fee on assets invested through its institutional retirement plan recordkeeping platform into Vanguard products, including the firm’s popular suite of index-based target-date funds (TDFs) and collective trusts.

The announcement grabbed attention for some obvious reasons, including that Fidelity and Vanguard are two of the largest-volume providers of retirement plan recordkeeping and investment products for defined contribution (DC) retirement plans in the U.S.

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Fidelity has since confirmed that the nominally small fee “applies only to new clients,” but given the sheer volume of business conducted by Fidelity and Vanguard in a given year, the fee change could result in a significant amount of new revenue for Fidelity. Fidelity is still in the process of rolling out the fee on its recordkeeping platform, according to a spokesperson for the firm, so it is a little too soon to tell how clients may react. However, the firm’s salespeople may soon have more information to share, the spokesperson said.

Confirmation that the fee story is still somewhat in development/deployment comes as it was also revealed by Vanguard that this fee was announced first to journalists and only afterward to Vanguard—catching the firm “completely by surprise,” as a Vanguard spokesperson candidly admits.

A look back at the announcement

In first announcing the fee, last month, a Fidelity spokesperson indicated that working with Vanguard “imposes unique operational requirements that generate extra costs for Fidelity.” She also stressed the firm “is not removing any fund families from our platform, but we are requiring that all fund families compensate us for our services in order to remain in good standing.”

Specific to Vanguard and leading to excess uncompensated costs, according to Fidelity, is that Vanguard has a requirement that plan-level trading activity and large trade-notifications be submitted by 3 p.m. EST, or an hour prior to market close. Fidelity says this has created increased complexity for its platform and its plan sponsor clients in that “we have had to implement an earlier daily cut-off process, ensuring the trade notifications will be analyzed, reviewed and submitted to Vanguard—minimizing any trades being rejected.”

For its part, and with a respectable amount of candor, Vanguard admits it was completely caught by surprise by this move and is still, to some extent, waiting to hear directly from Fidelity about exactly how and why the fee is being implemented—and whether it is impacting clients’ choices with respect to Vanguard product. One concern for Vanguard, left unspoken by the firm in subsequent interviews but made clear enough upon a little reflection, is that the fee hike on Vanguard products will make Fidelity’s own proprietary target-date funds and other products look marginally more appealing from the cost perspective.

Fidelity plays hardball, and Vanguard’s take  

In hindsight, Vanguard’s candid admission that it only learned of this new fee through media reports, including PLANADVISER’s, is more than a little revealing of the way large retirement plan providers craft and executive their competitive strategies—and their marketing approaches. Notably, Fidelity explicitly told reporters on the day of its announcement that it “had been in conversation about this new fee for some time with [their] business partners.” Per Vanguard’s comments, it wasn’t included in the conversations, so it stands to reason that Fidelity was likely having these discussions with at least some of its own and Vanguard’s competitors.

Crucially, the secrecy of their pending move allowed Fidelity leadership to solely define the narrative of what the new fee is and represents. The original Fidelity statements stressed the point that “this is not a distribution or revenue sharing fee; this fee is for administrative services that we are not compensated for.”

Asked to talk freely about these developments, a Vanguard spokesperson suggests a few things have been misrepresented in other media reports in terms of describing the way Vanguard’s unique business operations lead to excess costs for Fidelity.

“One thing that I have seen in some of the articles is the statement that Vanguard does not pay third-party providers a distribution fee, but there is no context or explanation given for what this means,” Vanguard’s Laura Edling says. “Vanguard has a structure that is pretty much unique across the industry, by which I mean we are owned by our funds, and in turn by our clients who invest in these funds. Because of this structure, we feel that we cannot charge that sort of distribution fee to our funds due to a potential conflict of interest. If we were to pick and choose which platforms we paid in this way, it would potentially put all our investors at a disadvantage. It’s a subtle point, but it’s important.”

Another way to state the concern is that, in charging distribution fees to its funds, Vanguard essentially would be charging and paying itself for distribution.

Edling went on to question how Fidelity came to the 5 basis point fee figure, even supposing that it is losing some amount of revenue based on the way Vanguard structures its business. “I think some people may ask themselves if the size of the fee being charged is on par with what other providers might choose to charge in this circumstance,” Edling suggests. Especially when one looks at the volume of product that Vanguard sells on the Fidelity platform, she notes, even though this is a small basis point number, in the end this is a potentially significant new flow of revenue.

In the end, both Vanguard and Fidelity agree this development in the evolution of fees and discussion of provider payments is a positive thing for clients and the industry.

“We are seeing a steady drumbeat of the march towards greater transparency across the retirement plan industry, so in that respect, it is a good thing if this new structure makes it clearer what fees the participants are paying to what providers,” Edling agrees.

Strategic Perspective Is a Key Commodity During Bouts of Volatility

As recently as mid-2016 it was common to hear advisers describe significant market volatility as the new normal, but since then the global equity markets have been remarkably stable and generous; so it makes some sense, experts agree, that investors are feeling jittery as volatility returns to the fore.

As senior vice president of strategic markets for Hartford Funds, John Diehl spends a lot of time talking to advisers in the field about all sorts of evolving topics over time. Lately, Diehl has been focused on helping advisers digest and understand the changing landscape in which they operate—not just speaking to the shifting regulatory and market outlook, but also addressing the “fundamental changes occurring in our society with respect to the life transitions and retirement income challenges that happen as a result of extended longevity.”

Speaking frankly and honestly about these topics is always beneficial, Diehl tells PLANADVISER, but during focused bouts of market volatility, of the sort witnessed in the equity markets this week, they increase even more in importance.

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“As advisers, these bouts of volatility actually present a challenge and an opportunity for you to go back to the fundamentals that everyone should regularly be focusing on,” Diehl says. “In this respect, the longer-term context of this week’s market moves is crucial to emphasize. Market gains in the U.S. and globally have been really strong over the last several years for those who have been strategic and patient, so you need to remember this as you view the market moves occurring right now.”

Yet the data from the Alight Solutions 401(k) Index already shows participants are reacting poorly to this latest round of stock market volatility, with trading activity described by researchers as “exceptionally high over recent days.” Trading on Monday was almost 12-times the “normal” level of trading. The last time the 401(k) plan market saw this level of trading was August 2011, coinciding with the last time the S&P 500 saw its biggest single day drop.

“We typically see a spike in trading activity when the market corrects, and Monday was no exception,” says Rob Austin, head of research at Alight Solutions. “Many investors who spent the weekend hearing about how the stock market posted its worst week in years were quick to make changes and sell some of their equities.”

Pullback follows lasting, impressive growth

Based on data provided by Northern Trust Asset Management, institutional plan sponsors had a very strong year of investment gains in 2017, with the median pension plan returning approximately 15.3% in the 12 months ending December 31, 2017. These numbers are based on the Northern Trust Universe, which tracks the performance of approximately 300 large U.S. institutional investment plans, with a combined asset value of approximately $927.5 billion.

Granted, the Northern Trust Universe considers large pension plan sponsors that may have their own unique portfolio approaches which do not exactly match what an individual investor in a defined contribution (DC) plan or a brokerage account could achieve, but that’s really beside the point. The fourth quarter of 2017 marked the ninth consecutive three-month period of gains for institutional investors in the Universe, with equities providing the foundation for positive results over that period.

As noted by Mark Bovier, regional head of investment risk and analytical services at Northern Trust, all plan sponsor segments had median returns above 3% in the fourth quarter of 2017 alone. Important to note, he says, “Each segment took a different path to achieve those gains.” Equities led all asset class returns in the fourth-quarter of 2017, with the median U.S. equity program in the Northern Trust Universe up 6.1%, followed by non-U.S. equities with 4.9% in the period. Fixed income was up a modest 0.7% in the quarter.

On Diehl’s analysis, it makes a lot of sense for advisers to be keeping these numbers fresh in their clients’ minds as they contemplate the ongoing equity market swings. And this contemplation should be done within the context of a broader strategic conversation about risk and reward.

“The context is so crucial. Market gains have been really strong over the last several years, so you need to remember this and remind clients of this,” Diehl says. “I think that, depending on how long this volatility sticks around, the behavior of clients could start to change for the worse, if we are not careful. At the time of this conversation it has only been about a week since the violent resurgence of volatility. The longer these swings stick around, naturally the more jittery people will become, and this could become a problem, to some extent.”

As he talks with advisers in the field, Diehl says there is awareness of this possibility, but clients aren’t over-reacting yet, at least as far as he has seen. Again, attitudes could change if the roller coaster of the last week becomes an extended period of loss. It is funny, in a sense, to note that investors never flee the market during a rapid period of gain, which also equally qualifies as an “extreme volatility” event. 

“Perspective is the thing that clients need the most right now,” Diehl concludes. “If you are able to put volatility in the right framework, it can be a healthy catalyst to ask great questions and improve your portfolio positioning. Clients must be contemplating whether they understand the risks they face and whether they have done the appropriate reviews and rebalancing of their long-term strategic objectives, and finally how these are translated into day-to-day trading decisions. We use the phrase ‘intentional investing.’ It’s not just about gliding along and reaping returns and then running away when markets hit a speed bump.”

What about the fixed-income picture?

PLANADVISER also caught up with Doug Peebles, fixed income chief investment officer for AB, to get the latest on the fixed-income picture against the background of greater equity market uncertainty.

“I actually think that, in a funny sense, 2018 will be the year where the fixed-income markets do actually get back to some semblance of normal,” Peebles says. “The important context to keep in mind in the fixed-income world is that, since the financial crisis in 2008 and 2009, central banks around the world have printed a tremendous amount of money, underlying the effort to provide ‘quantitative easing.’ This, of course, was meant to support asset prices and to ensure that higher asset prices and wealth fed into and increased capacity to spend, both for governments and for corporations.”

On his analysis, this initial strategy was quite wise. 

“But, at that time I never would have guessed that we would have seen central banks continue this strategy, globally, to reach the amount of money that has been created since the financial crisis,” he explains. “The result is that, broadly speaking, we had a situation develop over the decade where asset prices flourished and repeatedly set new records, while the economies underlying the equity markets did not necessarily fully reflect that growth. After all of this, 2018 will mark in some ways, a final reversal of the quantitative easing program and a return to normal.”

Speaking directly to the issue, Peebles points out that over the last five years, the average yield on the 5-year treasury has been 1.50%, and the low was 68 basis points. Today the yield is 2.60%.

“At the end of the day, there is still a fairly healthy global demand for long-dated lower risk assets, whether it’s coming from pension funds or insurance companies, or others,” Peebles concludes. “By the end of 2018, we can project that the central banks in aggregate will become net sellers of securities. At the same time you have a fiscal policy in the U.S. with the Tax Cuts and Jobs Act that has not come along with a spending cut. … All of this ultimately comes out in the price of fixed income, and the fact that price of fixed income is going down and the yield is going up shows we’re not at equilibrium on the fixed-income side.”

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