When Every Basis Point Counts

Here's how to lower investment management fees by leveraging institutional funds and separately managed accounts.

When the economy and the stock market were flying high, reducing 401(k) plan costs ranked low on the corporate agenda. After all, plan assets were racking up double-digit returns, employees eagerly contributed to their 401(k) accounts and companies had plenty of cash to match those contributions.

Today, none of those conditions still holds. Many investments are experiencing losses or only small gains. Every basis point counts, so businesses and their employees are paying close attention to the costs associated with their 401(k) plans.

In a recent study of 144 organizations with a total of 1.9 million 401(k) participants conducted by human resources outsourcing and consulting firm Hewitt Associates, 50 percent of respondents said that they already have made an effort to reduce plan fees, and another 10 percent reported that they intend to do so.

"Plan sponsors are waking up to the fact that they have a lot of money invested through these plans, which pay millions of dollars in management expenses for investment options," says Paul Bracaglia, a Philadelphia-based partner with PricewaterhouseCoopers HR Services. "It doesn't make sense." He is seeing a trend toward less expensive investment vehicles such as institutional mutual funds and separately managed accounts.

Mutual fund companies are starting to get the message. At the end of August, Boston-based Fidelity Investments reduced fees on five of its stock-index funds. Fidelity's fees for these products had previously ranged between 19 basis points (bps) and 47 bps; it now charges 10 bps. Whether other mutual fund providers will follow suit remains to be seen.

In general, 401(k) plan fees comprise three elements: investment management, administrative and trustee fees. Investment management fees are usually charged as a percentage of plan assets, and they can account for 70 percent or more of plan fees, depending on the size of the investment. Administrative fees often constitute between 20 percent and 30 percent of total plan fees, and trustee fees generally account for about 5 percent.

Because investment management charges are paid by plan participants, most organizations have historically tended to focus their scrutiny of 401(k) costs on administrative and trustee fees. "But that is starting to change," says Pam Hess, defined contribution plan consultant with Hewitt Associates in Lincolnshire, Ill. "Companies are increasingly paying attention to [all components of] fund expenses because there is such a huge range in those fees," she notes, adding that mutual fund costs "have a big impact on plan performance." (See How Fees Affect Mutual Fund Performance.)