Options Abound for Revenue Sharing

There has been much discussion about fees/revenue sharing and how plan sponsors are tackling this issue.

Recently, I moderated a panel discussion at the West Coast Defined Contribution Conference in San Diego where panelists examined the complex issues facing plan sponsors as they work through the selection of what investment vehicle/share class is most appropriate for their plan.

Plans come in all different shapes and sizes and have different services provided by their record keepers, and plan sponsors often have different philosophies on fees.  Investment Committees across the country are struggling to understand the myriad of options, and the pros and cons of the different fee models available.

  • Should plan sponsors use revenue sharing to pay plan expenses?
  • Should they allocate revenue sharing back to the participants generating it? (Note that over the past few years, many record keepers have rolled out the capability to track participants’ daily investment allocations, thereby creating a newer option of allocating revenue sharing back to those generating it.)
  • Should they eliminate revenue sharing altogether?

At the conference, we heard from two plan sponsors about how they have tackled this issue and the participant reactions they received.  An investment manager provided an overview of how investment managers determine revenue-sharing agreements and the factors that impact the amount a manager is willing to provide.  Here are some of the key take-aways from the panel discussion:

  • Not all record keepers receive equal compensation from investment managers’ payment for administrative services.
  • Revenue sharing is paid by investment managers to record keepers as compensation for the services a record keeper provides to the participant/end investor (call center, statements, tax forms, etc.) that the investment manager would otherwise have to provide.
  • Record keepers that have operational functionality to send one “net” trade to investment managers per day often receive greater compensation than those that send both buy and sell trades for each separate plan that holds a manager’s fund or investment option.
  • Oftentimes a more expensive expense ratio can lead to being the least expensive “net” share class once revenue sharing is factored in and paid back to the participants generating it.
  • Collective Investment Trusts (CITs) are gaining traction in the DC space, although participants are often frustrated they can’t track the investment via a ticker symbol. Comments from the investment manager on the panel indicated data feeds from CIT managers are becoming more prevalent and, in the not too distant future, it is anticipated the performance will become more readily available to participants.
  • Plan sponsors often don’t consider the additional responsibilities that fall on them when they choose a separate account over a CIT or fund.  Some of those additional responsibilities include: reconciling monthly manager trades with the custodian; processing investment manager invoices; processing additional legal documents; etc.
  • Plan sponsors don’t have to choose the least expensive vehicle/share class, but they do need to document why they didn’t select it.

Most experts acknowledge that there isn’t one right way to determine what share class/investment vehicle to use. Given that, it becomes so important that plan sponsors spend time determining their fee philosophy up front, and lay that groundwork to make share class/investment vehicle selection somewhat of a non-event.  Fees should be a foundational topic for all those who oversee retirement plans. Plan fiduciaries need to identify all plan fees, document the reasonableness of those fees, decide how the fees should be allocated, and review this periodically.

With a well-developed philosophy, all committee members (whether new or experienced) will be able to follow exactly how the plan sponsor came to its decisions about fees and methodology. Whether it’s an official record or a working guideline, a documented fee philosophy is an important cornerstone of a sound process.

 

The opinions contained within this document are those of Pavilion Advisory Group Inc. (“Pavilion”) and is subject to change based on changes in the firm’s opinions and other factors such as changes in market or economic conditions.  Pavilion has relied on the use of third-parties in the preparation of this material. While we believe our sources to be reliable, we cannot be liable for third-party errors or omissions.  The information should not be construed as an offer to sell or the solicitation of an offer to buy any security and does not constitute investment advice. 

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