Any 401k plan sponsor in America – repeat ANY – can buy market returns dirt cheap. There are no economies of scale in the market for indexed investments. No minimum purchase requirements. No high pressure sales pitches. Buy an index mutual fund or ETF and you’ve locked in market returns. As I have written previously, this indexed approach is the new baseline for small business 401k plans.
Now take one step toward attempting to outperform the market and you enter a whole new world. Like stepping out of a zen garden directly onto Times Square.
I’ve got no problem with either approach. Beauty is in the eye of the beholder. Differences of opinion make markets.
I blasted MEPs (Multiple Employer Plans) last week because industry pundits seem to think that all plan sponsors are chasing alpha and need scale to achieve “buying power.” People are writing as if index investments don’t exist – even though passive index funds are capturing the majority of all cash inflows into small business retirement plans.
Here is one reaction from Bob Toth, “a long-time corporate attorney, … with a pedigree in the financial services industry”:
“Those who are familiar with the small end of the 401k market know of the pressure to adopt proprietary funds with the highest expense loads; the limited access to competing fund families; the lack of affordable expertise; and the often-lousy level of services which accompany the lack of scale.
… small employers do need to be able access the buying power which is only available with scale, for which it is still far too hard for them to obtain. The question is how it will most effectively be done.”
Here is another comment on scale, from Michael Barry, writing in “Plan Sponsor”:
“Small-plan sponsors can’t afford to be fiduciaries. And if you think about that fact, it should be obvious that if anyone – like, say, a consultant – tries to help the small-plan sponsor do what a fiduciary should do – create the sort of fund menu you see at a well-run large-company plan – he will probably charge more than it’s worth. The scale at these small employers simply isn’t there.”
With scale and the resulting “buying power,” sponsors joining MEPs will get high-quality actively managed investments cheaper than retail. I’ve yet to see anyone put numbers to that concept, but it sure sounds great.
Here is my problem with these “magic” MEPs. At what level do we achieve “scale?” And what will be the investment vehicle – mutual funds? If mutual funds are used, how much will small plan sponsors save? Very few funds have significant minimum purchase requirements, so the savings would be limited. True savings would come from aggregating about $1 billion and hiring institutional investment managers directly – just like the large pension and endowment plans do now.
Using a $1 billion threshold would mean aggregating 2,000 small plans that average $500,000 in assets to achieve scale. Sounds pretty complex from a recordkeeping perspective. Consider payroll processing. If each employer made biweekly payroll contributions, our MEP example would process 52,000 payrolls per year.
I agree that there are thousands of small business employers with lousy plans. They were sold “product” that likely touted investment performance – by non-fiduciaries. If we are going to improve the quality of small business 401k plans we need to set and enforce fiduciary standards for all 401k plan vendors. Until then, look for small business employers to continue to choose index investments for their plans.