WASHINGTON, D.C. – Speaking at the Investment Company Institute’s general membership meeting here today, Chairman Martin Flanagan told attendees that legislators’ concerns over mutual fund fees, particularly in 401(k) plans, may be misplaced. Such remarks left Jack Bogle, the industry’s scold and founder of Vanguard, who was in the audience, shaking his head.
“When policymakers examine the 401(k) system, they will be doing investors a disservice if they focus exclusively on fees,” Flanagan said in his opening remarks at the 49th annual investment management gala. Flanagan said that instead, investors and lawmakers should focus on ensuring a comfortable retirement for the nation’s 96 million fund shareholders—and that is best done by focusing on portfolio construction and proper diversification.
Fee sensitivity among lawmakers, and investors, stems from the prolonged bear market that began in 2000: In those dark days, revenue-sharing arrangements, common practice in the industry for years, were suddenly re-defined as a conflict of interest, and it was revealed that brokers and institutional investors were abusively trading funds (late trading and market timing scandals), dampening the return to mom-and-pop retail investors. In short, as a result of the bear market, the fund industry looked like a cabal of fat cats, feeding at the trough in cozy relationships with institutions while the retail set was getting the short shrift.
Regulators and lawmakers seized on that populist theme and mounted the bully pulpit to generate some excellent headlines (however, it took years to figure out which shareholders were harmed and by how much). Some fund shops, as a result of settlements with regulators, were forced to lower their fees in addition to paying hefty fines. Today, Congress is shining a spotlight on the 401(k) space – which is populated predominantly by mutual funds – to ensure that plan participants pay a fair price.
Flanagan disputed the contention that fees are too high, saying the mutual fund industry has done an outstanding job of keeping costs down while improving efficiency; a very competitive industry, it is marked by constant innovation and improving service levels. Flanagan noted that mutual fund fees have fallen by half in the last 25 years. Further, he cited data that show that in 2005, three-quarters of 401(k) stock fund assets were in funds charging less than 100 basis points. He also cautioned the audience to avoid the mentality that low costs are a guarantee of good results, alluding to a time when Enron and WorldCom shares were the low-fee investment options in their respective company defined contribution plans. “The low-fee approach could potentially push investors to make bad decisions,” he said. The rhetoric, however, was enough to make Jack Bogle, a member of the audience, shift in his seat and shake his head. Bogle undoubtedly has research to suggest otherwise.
Flanagan further argues that focusing reform efforts solely on fees will lead to the neglect of crucial retirement issues. “Too much focus on fees could also drive employers and workers to look only at holding down total investment costs—when they should be looking at how to provide investment growth by constructing portfolios with the full range of investment options to help build retirement nest eggs,” he told attendees.
He also congratulated his constituents for their work on the passage of the Pension Protection Act in 2006, which is expected to bolster 401(k) participation rates significantly, thanks largely to ICI lobbying efforts. Under the new law, plan participants will benefit from automatic enrollment, automatic contribution rate increases and advice from the managers that run the money. Assets held in 401(k) plans now stand at $2.7 trillion. Flanagan pledged that ICI will continue to work with policymakers to ensure that the value of mutual funds will endure over time.