Managed Accounts in 401(k) Plans: Their Value and Their Dangers
A “managed account” is a discretionary portfolio management service that makes investment decisions for individual participants within the confines of a 401(k) plan and its fund options. This service is fundamentally computerized advice (aka “robo” advice), but with the help of a personal representative. Managed account services are typically available on 401(k) record-keeper platforms as an a la carte feature that the plan sponsor may or may not choose to activate. Quite often, the cost for this service is less than what an outside advisor might charge a participant for similar services.
Managed account services appeal to 401(k) participants who are not comfortable allocating their contributions among their fund choices. But why should a participant choose this service if their plan already offers any array of “target date” funds that automatically change their allocation as the participant ages toward retirement? The reason is, managed accounts allow for customized asset allocation. Age and age-based risk tolerance are generally the lone factors that determine asset allocation in target date funds. In contrast, managed account services look at additional factors – such as outside assets, other pensions, personal savings rates, income and a personalized risk tolerance – to determinate an appropriate asset allocation. All of this could in theory be done by the participants themselves using free online computerized advice (think Financial Engines) available on their record-keeper’s platform. But in truth, many participants need hand holding. Hence, the need for a personal representative to engage with the participant (frequently) in one-on-one communication to construct an optimal, personalized asset allocation strategy.
To be sure, managed accounts are in concept a good thing. However, in reality, managed accounts raise potential pitfalls for plan sponsors. The first pitfall stems from the level of fees charged by managed account services. These fees often start around 60-50 bps and then ratchet downward for larger participating account balance. Thus, an account with a balance over $250,000 may be charged 30 bps, whereas a balance below $100,000 may be charged 50 bps. Even at the lower end of the fee range, we are looking at fees considerably higher than the usual 7 or 8 bps cost for passive target date funds. The question is, can a participant with a modest balance of $50,000 expect superior performance from a personalized asset allocation (that chews up 60 bps annually) sufficient to outperform an off-the-shelf target date fund option? More fundamentally, is that participant actively engaged in the service – that is to say, providing unique participant data – so as to achieve maximum personalization, or is the service itself filling in basic data due to participant passivity? The more basic the data, the more the managed account looks like an expensive target date fund. These are important issues that we think few plan sponsors take the time to examine. Remember, managed accounts are not a fund option; rather, they are a fiduciary advice service. As with any other advice service, utilization and performance must be monitored.
The second pitfall, and really the core reason for this blog article, stems from the growing linkage of record-keeping fee levels to the offering of managed account services. In other words, a record-keeper may quote to a plan sponsor a per-head annual fee of $40 for record-keeping/TPA services, but offer to lower that per-head fee if managed accounts are offered. The record-keeper expects to receive revenue from the managed account services that likely will surpass the lost recordkeeping fees. In our view, this linkage may be a red flag. By linking fees, the plan sponsor is creating an environment where managed account users are effectively subsidizing the cost of record-keeping fees that should be borne by participants as a whole. Sound familiar? This was exactly the issue with revenue sharing, and exactly how many plan sponsors found themselves in hot water with the DOL and plaintiffs lawyers. Many of the plan sponsors also were not even aware of the amount of revenue being collected by their record-keepers from revenue sharing, and unfortunately today it may be little different with managed accounts. History tends to repeat itself because we don’t fundamentally understand the lessons from past mistakes. Revenue sharing was not inherently bad, but using it in a manner that led to inequitable allocation of plan-wide costs was inherently bad. The same is true with managed accounts.