At PLANADVISER’s Top 100 Retirement Plan Advisers seminar in New York City last week, Ken Rogers, founder and president of Rogers Financial, and Philip Steele, president and CEO of Pension Architects, discussed the pros and cons of using an open architecture plan design. But before a pro and con list could be thoroughly understood, a clearer idea of what it involves was required.
What is open architecture?
Rogers helped shed some light on what open architecture involves; it is not just being able to add non-proprietary funds to a plan’s lineup. The recordkeeper, investment manager(s), and custodian/directed trustee are all separate entities. The recordkeeper has the ability to trade virtually any mutual fund or exchange-traded fund (ETF), and has a stable of custodians/trustees from which to select. There are no proprietary investment requirements. Fees for services are fully disclosed, and offset by any revenue sharing provided by investment company (sub-TAs or 12-b1 fees for instance).
It is critical to realize that open architecture is not right for every plan sponsor. Before recommending open architecture to a client, there are a few questions to weigh, said Rogers. How important is flexibility to the client? How important are total plan fees and fee transparency? And how sophisticated are the participants? It’s important to know these things because open architecture might require that a sponsor include funds on a menu that will produce a certain amount of revenue to offset recordkeeping fees. And although decision-makers of the plan might think flexibility is important, participant behavior might prove otherwise.
Steele suggests that advisers look at open architecture in five parts. First, there is fiduciary oversight. The sponsor wants the adviser to build a plan he or she feels is strong, but at the end of the day, the sponsor wants protection. The most important component, according to Steele, is participant education. He says it needs to really robust and involve more than just directing participants to a Web site. After those first two elements are given an ample amount of time, the adviser can then consider plan investments, plan costs, and customizing overall plan design. Steele recognizes that it requires a lot of work, but when done correctly, it can really make a difference in people’s lives.
Pros and Cons
In his experience, Rogers has seen several pros and cons of open architecture. The pros include:
- The ability for an adviser to offer any mutual fund option to a plan is a great way to show value.
- The need to change recordkeepers because of poor fund performance disappears.
- The customization is appealing to clients.
- It can signal to a prospective client that you are willing to go that extra mile for them.
The cons of open architecture include:
- Requires the adviser to work only in a fee-based capacity.
- Takes more work and time to service an open architecture plan.
- Technology offered by most open architecture providers is not as robust as most bundled providers.
- The level of revenue sharing provided to the open architecture provider can significantly affect the economics of the plan.
All of these pros and cons came to fruition with one sponsor in particular, said Rogers. Rogers Financial was hired as the registered investment adviser (RIA) on the plan after the decision was made to leave a bundled provider for an open architecture one. However, when making the decision to leave the bundled provider, the client had assumed that the proprietary requirement was higher than it actually was, he said. Further, the fee disclosure provided by the open architecture provider assumed “mapping” that was "dubious," Rogers said. Although the fund menu suggested in the proposal was reasonable, the share classes used by the open architecture provider contained above-average fees given the plan demographics.
However, after Rogers recommended a more prudent fund menu to the client, the billable fees came in higher than that of the bundled provider. The recordkeeping fees, which were billed quarterly, were often inconsistent because the revenue sharing from some fund companies lagged. The technology and customer service was not up to par with that of the bundled provider. The plan participants, though adequately diversified, did not appreciate the differences between funds, but did notice when their employer began to pass fees off to them, which they had not seen under the previous provider.
Rogers said that after having gone through that process, the client is now considering proposals from other bundled providers.