march 12, 2007 401(k) plan fees … how does your plan compare? 2007 benefits new york show and...

March 12, 2007March 12, 2007

401(k) Plan Fees … How does your Plan compare?

2007 Benefits New York Show and Conference

401(k) Plan Fees … How Does Your Plan Compare? | | 2

About Your Presenters

Michael Crowley is Associate General Counsel for the National Futures Association, the industry wide, self-regulatory organization for the U.S. futures industry. For 15 years, Mike has advised NFA’s benefits committee and senior management on issues concerning retirement and health benefits. In those years, Mr. Crowley has been an integral part of NFA’s efforts to build a comprehensive retirement benefits program with particular focus on aiding the benefit committee in discharging its fiduciary responsibilities in the operation of NFA’s retirement plan.

In addition to his work in the benefits arena, Mike heads NFA’s legal department who license all futures professionals in the United States. He also provides legal advice to management on a variety of other issues, including intellectual property, privacy, insurance and contracts.

Mike received his B.A in Political Science from the University of Illinois and his J.D. from Chicago Kent College of Law. Before joining NFA, he prosecuted slumlords in the office of the Cook County, Illinois States Attorney and represented indigent clients at the Legal Assistance Foundation of Chicago.

Wayne G. Bogosian is founder and President of The PFE Group, Southborough, MA, a leading retirement plan vendor search, investment advisory and financial education consulting firm. Wayne is a frequent public speaker, having conducted more than 1,000 workshops and seminars on topics ranging from retirement planning and investments to corporate downsizing and mergers and acquisitions. He is co-author of The Complete Idiot’s Guide to 401(k) Plans and has been quoted in a variety of publications including Business Week, CNNMoney, Employee Benefit News, Reader’s Digest, USA Today, Wall Street Journal, Washington Post, and appeared on WCVB, MSNBC, and AOL.

Wayne has a B.S. from Northeastern University, an M.B.A. from Suffolk University, is an Accredited Investment Fiduciary (AIF), and holds various securities licenses.


Workshop Objectives

What’s all the fuss over 401(k) plan fees?

What fees are sponsors and participants paying?

What is a “reasonable” fee for:– Investment Management?

– Plan Administration?

How can plan fiduciaries protect themselves from fee-related lawsuits?

What actions should fiduciaries take?


What’s the fuss over 401(k) plan fees?

401(k) Fee Lawsuits– ABB, Bechtel, Boeing, Caterpillar, Deere, Exelon, General Dynamics, Int’l Paper,

Lockheed Martin, Northrop Grumman, United Technologies – Claim: Fiduciaries were “unaware” of plan expenses– Claim: Plan expenses were undisclosed– Claim: Revenue sharing arrangements between service providers and fund

managers were: (1) not properly disclosed to sponsor or participant, (2) not used for the benefit of participants, (3) fiduciary breach

– Claim: Active managers were “shadow index funds”– Claim: Employer Stock Fund cash holdings reduced return; asset based fees

charged for administration– Plaintiffs asking for:

Monetary relief (direct losses and investment losses) Jury trial

Fee-Related Regulations Likely– House Chair George Miller (D-CA) will initiate hearings – DOL to issue fee-related guidance in 2007– New “Required Disclosures” are likely– At issue: pro-rata vs. per capita fees– Fee disclosures to participants?


Are You Ready for Full Fee Disclosure?

Relate these questions to your retirement plan? Yes NoDon’t Know

1. We have identified those services which are considered necessary to the effective and efficient operation of the plan?

2. We have identified all fees charged for necessary services and confirmed (a) who is currently paying the fee (participant or sponsor) and (b) how the fee is being assessed (pro-rata or per capita)?

3. We have identified all Plan Administration services (and fees) which

are currently paid through plan investments? 4. We offer less expensive share classes today (if possible) than we did

three years ago? 5. We have re-negotiated our plan fees (or moved our business) within

the past three years? 6. We have benchmarked our plan services and fees to similar plans in

the past three years? 7. Total plan expenses are reported to plan fiduciaries at least once

each year? 8. An independent investment advisor, who is a fiduciary of the plan,

regularly reviews our plan’s services, investments and fees? ERISA § 406(a)/408(b)…

“Prohibited transaction occurs if plan assets are used to pay service providers more than reasonable compensation for their services”


Required Fee Disclosures

Investment Fees Prospectus– Fund Expense Ratio

– Contingent or Short-term Redemption Fee

Administration Fees Enrollment Form, SPD, 5500, SAR

– Recordkeeping Services

– Loans and Distributions

– Transactions

– Compliance, Legal, Investment Advisory, Audit


Required Fee Disclosures (continued)

GAO Report – Inv Mgt and Recordkeeping fees dominate

– Fees are primarily paid pro-rata

– Only net returns are shown (i.e, can’t determine a fee’s impact)

– Laws governing 401(k) plan fees are limited in scope & do not provide for easy comparison

– Fee and expense disclosures are presented in piecemeal and confusing ways

– Revenue sharing arrangements between providers (services and funds) may contribute to higher fees

– Recommendation:Disclose all fee-related informationProvide for easy comparison between fundsReport all fees paid from plan assets and paid by participants


How do fees impact return?

FeeFee as a % of

Invested Assets% Return

Fund Gross Return 10.00%

Investment Management Fees 0.45%

Subtract All Fees1.10%

Distribution and Shareholder Fees (e.g., 12b-1) + 0.25%

Other Expenses of the Fund (audit, legal, etc.) + 0.40%

Expense Ratio (Total Fund Operating Expenses) = 1.10%

Fund Net Return (Net Asset Value) 8.90%

“What am I paying for?


It takes a lot to service a 401(k) plan!

Guiding Influencesa) Plan Sponsor b) ERISA, DOL & IRCc) Plan Documentd) Investment Policye) Consultants

Primary 401(k) Service Provider

Trust & Custody

CustodyTrading

ReconciliationReportingPayments

Distributions

Administration

Participant Accounting Trans. Processing

Technology

Compliance

ERISA & IRCDiscrimination

FilingsRestatements

Sponsor Support

ConversionRelationship Mgr.

Support TeamOnline ReportingM&A, Divestiture

“What is the true cost of 401(k) plan administration?

Participant SupportCustomer RepsOnline &VRS

Print, Web, DVD Meetings

StatementsNotices

Prospectus


What fees are Sponsors and Participants paying?

VENDOR SERVICE SPONSORPLAN

(Participant)

ADMINISTRATION FEES

Account Recordkeeping (Daily tracking of all activity)

Account Payments (Loans, QDROs, Distributions, Rollovers)

Account Access (Online, VRS, CSR) Communication (Prospectuses, enrollment kits, statements, fact sheets, fund changes, required notices, CRF disclosure)

Education (Participant meetings, one-on-one) Investment Oversight (Independent Investment Counsel) Compliance (ERISA counsel, required testing, form 5500) Audit (Required for plans > 100 participants)

Trust & Custody ASSET MANAGEMENT

Investment Performance


Which investment-related fees might 401(k) Participants pay?

FUND EXPENSE DEFINITION

Applies to Most

401(k) Plan Investments

LOAD Sales charge for buying or selling a mutual fund

Front-end Load Initial Sales Charge for buying a mutual fund (generally 1% – 8.5% of invested assets) NoBack-end Load Deferred Sales Charge for selling a mutual fund. Also called Exit Fee or Deferred Load (up to 5% of redemption) No

Declining Load Declining fee (e.g., begins at 10% and reduces to 0% by year 10) NoNo Load Fund Mutual fund that is sold without a load (i.e. no sales charge for buying or selling shares) Yes

WRAP FEEAnnual fee for an investment program that bundles together investment services such as advisory, brokerage, research and management. Wrap Fees may be charged in addition to all other fund fees and loads No

EXPENSE RATIO Mutual fund's cost of doing business; passed on to all shareholders – expressed as a percentage of assets Yes

Investment Management Fee Fee to investment manager for their services. Typically a percentage of average net assets invested in fund Yes

Distribution Fee or Shareholder Service Fees (aka 12b-1 Fee)

Fees paid by the fund to cover marketing, sales and shareholder services. "Distribution Fees" compensate brokers and other intermediaries who sell fund shares, pay for advertising, printing and mailing of prospectuses and sales literature. "Shareholder Service Fees" compensate those persons who respond to investor inquiries. Shareholder Servicing Fees can be paid inside or outside of a fund

Yes

Other ExpensesIncludes all expenses not listed above, including custodial, legal, accounting, transfer agent, and other administrative expenses of the fund Yes

EXCHANGE FEE Fee imposed when shareholders exchange (transfer) their shares to another fund within the Plan No

REDEMPTION FEEFee for selling mutual fund shares within a short period of time (e.g., 2% charge if sold within 90 days of purchase); a.k.a. “Short-term” or “Contingent” Redemption Fee. These fees are paid back to the fund Yes


Sources of Provider Revenues (“Economic Benefit”)

Proprietary Product Placement– Fully “bundled” using ALL/MOSTLY proprietary product is MOST profitable– Internal “revenue crediting rates” (for proprietary funds) differ by fund company– Default fund option (Stable Value, Life Cycle, Managed Accounts)– Spreads (fixed income products)

Non-Proprietary Product Revenues– Revenue Sharing Arrangement– Sales Commission– Yield Spread – 12b-1 Fees – Sub Transfer Fees– Shareholder Service Fees– Brokerage “shelf-space” Fees– Preferred Provider or Placement Fees– “Soft-dollar” Brokerage (proprietary & third-party research)– Directed brokerage (for investment products other than mutual funds)– Other: Allowances, Subsidies, Conferences, Reciprocal Referrals, Directed

Brokerage, Rollovers upon Termination


How do 401(k) Service Providers make their money?

INVESTMENT CATEGORY

INVESTMENT OPTION

EXPENSE RATIO (Component Parts) (%)*

EXP. RATIO*

CATEGORY AVG EXP.

RATIO (%)*

REVENUE SHARE TO SERVICE

PROVIDERInv. Mgt. Distribution Other

Cash Equivalent Proprietary Stable Value 6 bp 0 bp 44 bp 50 bp N/A 44 bp

Fixed Income PIMCO Total Return (Ins) 25 bp 0 bp 18 bp 43 bp 102 bp 0 bp

Allocation Strategy Moderate Allocation Strategy 40 bp 0 bp 18 bp 58 bp 108 bp 16 bp

Balanced Proprietary Balanced (Ins) 75bp 0 bp 11 bp 86 bp 113 bp 75 bp

Allocation Strategy Aggressive Allocation Strategy 63 bp 1 bp 11 bp 75 bp 113 bp 22 bp

Real Estate Morgan Stanley Ins U.S. RE (A) 76 bp 0 bp 13 bp 89 bp 154 bp 10 bp

Large Cap Value Proprietary Equity (I) 80 bp 0 bp 0 bp 80 bp 134 bp 50 bp

Large Cap Index BGI Equity Index (Q) 5 bp 0 bp 1 bp 6 bp 115 bp 1 bp

Large Cap Growth Growth Fund of America (R5) 28 bp 0 bp 8 bp 36 bp 142 bp 5 bp

Mid Cap Value Janus Adviser Mid Cap Value (I) 64 bp 0 bp 11 bp 75 bp 141 bp 10 bp

Mid Cap Index Vanguard Mid-Cap Index Adm 11 bp 0 bp 2 bp 13 bp 143 bp 0 bp

Small Cap Value Third Avenue Small-Cap Value 90 bp 0 bp 23 bp 113 bp 155 bp 0 bp

Small Cap Index Vanguard Small-Cap Index Adm 10 bp 0 bp 3 bp 13 bp 144 bp 0 bp

Small Cap Growth Baron Small Cap 100 bp 25 bp 8 bp 133 bp 166 bp 35 bp

International Proprietary International (I) 80 bp 0 bp 0 bp 80 bp 153 bp 50 bp

Source: Morningstar 2006; Fund Prospectus


About NFA

• Founded 1982• Nationwide Self-Regulatory Org. for

US Futures Industry• Not for Profit• 249 Employees• $51M 401(k)/Profit Sharing Plan• 99% Participation; 7.14% Avg. Deferral• Auto-enrollment @ 6%• QDIA – Balanced Fund • 13 Funds plus 3 AA Funds• Avg. participant uses 7 plan funds• Formal Plan Oversight


Fiduciary Committee – Plan Oversight

Retained Responsibilities (Non-Delegated)– Fiduciary Oversight (“Benefit Plan Trustees”)

– Committee Charter and Investment Policy

– Fund Manager Performance

– Fee Analysis (Total and Vendor-specific)

– Service Provider Oversight

Delegated Committee Responsibilities– Trust (directed-trustee)

– Plan Administration (day-to-day recordkeeping)

– Investment Advisory

– ERISA Counsel

– Communications and Education


“State-of-the-Plan” Report to Board of Directors

Purpose: Inform Board of the Actions of their Appointed Fiduciaries– Plan Amendments and Material Modifications

– Claims and Appeals

– Plan Administration

– Plan Demographics

– Plan Qualification

– Litigation

– Agents (ERISA Counsel; Investment Advisor)

– Plan Expenses

– Plan Funds


Plan Fees Paid by Participants

EXPENSEANNUAL PARTICIPANT PAID FEES

(based upon Invested Plan Assets of $50,500,000 as of 12/31/2006)

Fees for Plan Administration $131,144 or

$338/participant26 basis points

Fees for Investment Management, Shareholder,

Distribution and Other Services

$235,788 or $608/participant

47 basis points

Total Annual Fees Paid by Participants

$366,932 or $946/participant

73 basis points

NFA’s Average Account Balance is ~ $132,000


Which is the right way to allocate expenses?

Pro Rata Large Accounts

Pay More

Per CapitaEveryone Pays the Same


Benchmarking Fees … Easier Said Than Done

Few Benchmarking Surveys Capture all Expenses– Loan, Distribution, and Ad Hoc Fees can be substantial – Managed Account fees are often not counted – Expenses paid by plan sponsors are often not reported (as a result overall fee looks low

when compared to all-in expensing)

Not all Plans are created equal – What provider services do you use?– How complex is your plan design?– How “demanding” are you?

What services are of value to “your” plan and participants, but incur additional cost?– Independent Investment Advisor– ERISA Counsel– Demographic-specific communications– Financial education and one-on-one counseling

Index and ETF Plans vs. Active Manager Plans – Active Manager Plans tend to look expensive when compared to all-Index or ETF plans – Expenses alone do not tell the entire story; return and risk must also be included


Comparing Cost and Performance

COMPOSITION

Asset Class/Style Class FundModerate Allocation Aggressive Allocation

Naïve* Index Fund Naïve* Index Fund

Cash & Equivalent Schwab Stable Value 10% 10% 10% ------ ------ ------

Investment Grade Bonds PIMCO Total Return D 50% 30% 30% 20% 12% 12%

Inflation-Adjusted Bonds PIMCO Real Return Instl ------ 20% 20% ------ 8% 8%

Large Cap Value Westwood Equity AAA ------ 11% 11% ------ 17% 17%

Large Cap Blend S&P 500 Index 40% ------ ------ 80% ------ ------

Large Cap Growth Growth Fund of America R4 ------ 9% 9% ------ 13% 13%

Midcap Value JP Morgan Midcap Value Sel ------ 5% 5% ------ 8% 8%

Midcap Growth Alger Midcap Growth Instl ------ 4% 4% ------ 5% 5%

Small Cap Value Royce Low-Priced Stock ------ 3% 3% ------ 6% 6%

Small Cap Growth Wasatch Small Cap Growth ------ 2% 2% ------ 4% 4%

Real Estate Third Avenue Real Estate Val ------ 3% 3% ------ 8% 8%

International Equity Amer Funds EuroPac A ------ 3% 3% ------ 14% 14%

Emerging Markets Equity Oppenheimer Dev Markets A ------ ------ ------ ------ 5% 5%

FIVE YEAR PERFORMANCE** (ending 12/31/2006)

Annualized Return 5.53% 7.80% 8.00% 6.15% 11.77% 11.92%

Alpha vs. Naïve 0.00% 2.31% 2.79% 0.00% 5.54% 6.06%

Beta vs. Naïve 1.00 0.97 0.92 1.00 0.95 0.88

R-Squared vs. Naïve 1.00 0.87 0.82 1.00 0.88 0.84

Standard Deviation 4.78% 4.96% 4.83% 9.72% 9.84% 9.34%

Sharpe Ratio 0.63 1.07 1.14 0.37 0.94 1.01

Tracking Error vs. Naïve 0.00% 1.77% 2.08% 0.00% 3.47% 3.88%

Information Ratio N/A 1.31 1.34 N/A 1.60 1.56


What’s Next From Washington?

Revamped Form 5500 – complete disclosure of all expenses paid by plan (w/o any context, of course)

Required disclosures/notices to participants

“Periodic” review of plan expenses by an “independent source”

Surprises?


A Fiduciary’s “Fee-Related” To Do List …

Service provider revenue/service assessment

Comparing plan investments and plan costs to correct benchmarks

Share class selection and monitoring

Service provider revenue capitation ($ or bp)

Default fund selection (Who recommended? What were revenue implications?)

Pension plan vs. 401(k) due diligence

Reporting fiduciary actions to Board of DirectorsIf you don’t know what you are doing …

ERISA requires you to find someone who does.


Thanks for coming!

Michael CrowleyAssociate General CounselNFA200 West Madison, Suite 1600Chicago, IL 60606(312) [email protected]

Wayne G. BogosianPresident, CEOThe PFE Group144 Turnpike Road, Suite 360Southborough, MA 01772(508) 683-1400, ext. [email protected]


Interpreting Modern Portfolio Theory Statistics

Annualized Return – the constant one-year rate of return on an investment which would result in the same total return as the actual annual returns over the performance period being measured. Example: A three-year investment has three yearly returns of +5%, -4%, and +10%, for a total return of +10.9%. The annualized return on this investment is +3.5%, since a return of 3.5% for each of the three years would result in the same total return of +10.9% with compounding.

Alpha – the expected return of the actively managed portfolio when the return of the index is 0%; it is determined by comparing the monthly or quarterly returns of the portfolio and the index over a period of time. A positive alpha is always good, although it is not abnormal to have a low alpha accompanied by a high beta (see beta below)

Beta – a measure of the market-related risk of a portfolio, expressed as a multiple of its benchmark. A beta of 1.10 means that the portfolio is 10% riskier than its benchmark; a beta of 0.90 means that the portfolio is 10% less risky than its benchmark. Modern Portfolio Theory states that higher betas should be rewarded with proportionally higher returns over long investment periods.

R-Squared (R2) – a measure of the effectiveness of the alpha and beta statistics in estimating the expected risk and return levels of a portfolio. As a rule of thumb, an R2 statistic of 0.70 or higher means that there is a significant relationship between the performance of the portfolio and the performance of the index to which it is being compared. Lower numbers are acceptable if the measurement period is longer, and vice-versa

Standard Deviation – a measure of the consistency of periodic returns of a portfolio or index over time. For any given twelve-month period, the investment has a 68% probability of producing a return within the range defined by its long-term average return plus or minus its standard deviation. Similarly, it has a 95% chance of providing a return in the range defined by its long-term average return plus or minus two standard deviations.

Sharpe Ratio – a measure of the tradeoff between the value added through active management of a portfolio and the amount of risk incurred through the management process. There is no constant number that is considered “good” or “bad”; the only objective for an actively managed portfolio is to produce a Sharpe Ratio that is higher than its benchmark. The Sharpe Ratio uses standard deviation as its measure of risk. (Note: The Sharpe Ratio statistic has a slight bias in favor of more conservative portfolios.)

Tracking Error – A measure of the similarity between the periodic returns of a portfolio and its benchmark. A low tracking error indicates a high degree of similarity, and vice-versa. Like the standard deviation statistic, the interpretation of tracking error is that a portfolio has a 68% probability of performing in a range defined by its benchmark return plus or minus its tracking error over any twelve-month period. There is no “good” or “bad” tracking error – it is simply a reflection of the investment policy of the portfolio manager.

Information Ratio – a comparable measure to the Sharpe Ratio in that it measures the tradeoff between return and risk; however, the return used is the alpha, and the measure of risk is the tracking error.


Disclaimers and AttributionsGeneral Notes The information contained in this document is as of December 31, 2006 and is believed to be accurate. Data was gathered from a variety of sources believed to be reliable, including

Morningstar, Mobius, Ibbotson Associates, Standard & Poor’s and other third-party administrators. Every attempt has been made to verify data; however, no guarantees or endorsements of accuracy are to be made. Any discrepancies between the numbers contained herein and other sources are unintentional.

Total returns include changes in share values and reinvestment of dividends and capital gains distributions, if any. Gross returns will be reduced by management fees and other expenses in an amount proportional to performance. For example, a fund with a gross return of 10% and an expense ratio of 1% will experience a reduction of 1.1%. Individual client performance numbers may differ from reported numbers for a fund due to contributions or withdrawals made during the performance measurement period. Past performance is no guarantee of future results.

Performance numbers calculated by PFE Advisors, LLC are compliant with AIMR standards. AIMR had no involvement with the preparation of this report.

All references to Company Plans reflect information that was available at the time of publication. Actual benefits will be based upon information and formulas contained in the appropriate Plan Document(s). The inclusion of non-plan funds in certain exhibits is for comparative purposes only, and does not imply an endorsement of those funds by PFE Advisors, LLC.

The information on specific investments contained in this document is not an offer to sell, nor a solicitation of an offer to buy, these securities. Plan sponsors should review fund prospectuses and other relevant information before making any investment decisions.

This presentation is for the exclusive use of PFE Advisors, LLC and its respective clients, and is not authorized for public distribution. All Copyrights are the property of their respective owners.

Index Definitions The S&P 500 is an unmanaged index of 500 large-cap domestic stocks that is commonly used as a proxy for the large-cap stock market. Historically, the index has targeted a

composition of 400 industrial companies, 40 financial companies, 40 utility companies, and 20 transportation companies. The index does not contain real estate investment trusts. Changes in the index composition may be made at any time. Performance numbers for the index are a size-weighted average of the performance numbers for each index constituent.

The Russell 2000 is an unmanaged index consisting of the smallest 2000 stocks in the Russell 3000 universe, which in itself consists of the largest 3000 publicly-traded domestic companies. This index is commonly used as a proxy for the liquid small-cap stock market. The index is reconstructed on July 1 of each year. Performance numbers for the index are a size-weighted average of the performance numbers for each index constituent.

The MSCI EAFE® Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the US & Canada. The index consists of the following 21 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom.

The NAREIT index is an unmanaged index of securities that meet the definition of Real Estate Investment Trust (REIT) and are traded on the NYSE, AMEX, or NASDAQ. REITs are investments in rental properties, and are required to pay out 95% of their earnings each year as dividends. Performance numbers for the index are a size-weighted average of the performance numbers for each index constituent.

The Lehman Aggregate Bond Index is an unmanaged index made up of the following fixed-income securities: all debt securities issues to the public by the U.S. Government or its agencies, as well as quasi-federal corporations or corporate debt guaranteed by the U.S. Government; all public obligations of the U.S. Treasury except flower bonds and foreign-targeted issues; all 15-year and 30-year fixed-rate securities backed by mortgage pools of GNMA, FHLMC, and FNMA, with the exception of graduated payment mortgages, manufactured home mortgages, and graduated equity mortgages; and all publicly-issued, fixed-rate, non-convertible, investment-grade, dollar-denominated, SEC-registered corporate debt securities with at least one year to maturity and an outstanding par value of at least $100 million.

©2007 PFE Advisors, LLC, an independent investment advisory firm and wholly-owned subsidiary of PFE Consultants, Inc. d/b/a The PFE Group.

march 12, 2007 401(k) plan fees … how does your plan compare? 2007 benefits new york show and...

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