A statistic in the Investment Company Institute’s June 2017 ICI Research Perspective, “The Economics of Providing 401(k) Plans: Services, Fees and Expenses, 2016,” caught my attention. The report broke down 401(k) mutual fund assets by share class, and the numbers for R share classes surprised me. R shares previously had experienced rapid growth, going from a 4 percent share in 2004 to 19 percent in 2010. Since then, however, their growth has slowed and reversed, falling to 18 percent in 2016. That decline is likely a result of growing no-load institutional classes, whose share increased from 31 percent in 2010 to 44 percent in 2016.
I asked several sources about their usage of R shares and their outlooks for the class. Responses on current use varied, but the opinions on future use of these shares was uniformly positive. Seth Priestle, CFP, investment analyst with Pension Corporation of America (PCA) in Cincinnati notes that his firm serves multiple roles. PCA is an investment advisor that focuses primarily on company retirement plans but also serves as a record keeper and third-party administrator. The firm itself uses R shares very sparingly, Priestle explains, primarily in plans that come through a broker/dealer.
The overall usage of R shares has decreased drastically, in Priestle’s experience. The remaining usage is from broker/dealers that are not registered investment advisors (RIAs) and are targeting a compensation level from the 12b-1 fee of, say, 50 basis points. Those plans are usually small, mostly under $1 million, he adds. The push toward adopting fiduciary status and providing increased transparency with fees are two factors driving the changes, says Priestly. “Transparency is a big push, so in a lot of cases, it’s easier to just use cheaper share classes or institutional share classes, and then just charge your standard investment advisory fee, so that everything’s a little bit more out in the open, less done behind the scenes,” he says.
Lee Topley, AIFA, managing director of the Retirement Plan Consulting Group at Unified Trust Company in Lexington, Kentucky, says that a large percentage of his firm’s $4.2 billion of retirement assets is in R shares. For its own clients, the firm is a named plan fiduciary and uses the R-6 share class for its low costs. “There’s no revenue-share associated with those funds, so the participant gets the complete experience of that fund without any fees that need to come out or anything from that standpoint,” Topley explains. “It’s the least-expensive share class or expense that can be provided for that participant.”
Using the R-6 class (also called “clean shares”) provides additional benefits to sponsors, Topley maintains. Many plan sponsors don’t have clear understandings of how fees work in the more complex share classes. Consequently, it can be difficult for sponsors to fulfill their fiduciary duties. “It’s very clear from the Department of Labor that they [sponsors] are responsible for completely and thoroughly understanding the distribution systems inside any of the mutual funds that they’re using, [and] what type of revenue-share is part of the mutual fund share classes that they’re holding within their plan,” says Topley. The R-6 and institutional share classes can save sponsors “a significant amount of work of worrying about where all that money’s going that’s sitting inside that revenue share stuff that’s being paid back to the record keeper,” he adds.
Topley and Priestle believe that more plans will be adopting R-6 shares over the next few years. Topley cites the ongoing trend among funds to reduce fees, particularly for qualified retirement plans. Priestle believes that plan consultants will work to eliminate potential conflicts of interest caused by varying compensation schemes that result from using multiple share classes with different compensation levels within the same plan. “You eliminate that conflict, so regardless of which fund the participant goes in, it’s paying the rep or the advisor the same fee,” says Priestle.
Jerry Bramlett, managing director at Sage Advisory Services in Austin, Texas, says via email the drive for plan fee transparency will make the non-clean shares increasingly rare, especially with larger, more sophisticated defined-contribution (DC) plans. He maintains that the use of clean shares, either as R-6 classes or ETFs, will grow due to the following factors:
- Many of the class-action DC lawsuits are focusing on the fact that it is imprudent to use any share class except the lowest-cost share class for which a plan qualifies.
- The fiduciary rule will only further reinforce the need to always act in the best interest of DC participants, which means always using the lowest-cost share class available.
- The continued expansion of either pure fee-based advisors and hybrids (fee and commission based) will ensure a steady drift toward an R-6 type of clean share.