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Trying Something New: Investor appetite for ETFs increasing

A Charles Schwab study found that 44% of individual investors plan to invest more in exchange-traded funds (ETFs) over the next 12 months. The ETF Investor Study also found that eight in 10 investors who currently own ETFs say they will invest more in them over the next two years.

The survey consisted of more than 1,000 individual investors with at least $25,000 in investable assets and familiarity with ETFs. The study was designed to gauge individual investors’ attitudes toward, and understanding of, ETFs, and how or whether they would use them as part of their investment portfolios. Nearly two-thirds of all respondents to the survey own ETFs; the other third plan to invest in an ETF in the next two years.

The study shows investors’ appetite for ETFs is rising in several ways: In addition to the 44% who plan to invest more, just 2% say they will decrease their ETF investments. According to the study, the increased interest is driven in part by a distinct set of benefits unique to the product. ETF owners say the biggest benefit of ETFs is that they trade like stocks, while those considering them cite diversification as the top benefit.

The study also offers insights about the gaps that still exist in investors’ knowledge of ETFs. Forty-six percent of investors surveyed call themselves ETF “novices,” and one-fourth of all respondents indicate that they do not understand ETF costs or how to best use them. Thirty-one percent of respondents say they don’t know how to use ETFs across asset classes, and more than 25% know nothing about the difference between actively managed and index-based ETFs.

Half of ETF owners surveyed say they use these products to access specific sectors or markets, and 44% use them to invest in core asset-allocation strategies. Sector ETFs were cited as the type most frequently evaluated for purchase, followed closely by equity and international ETFs. Thirty-four percent of respondents also report interest in commodity ETFs, and more than one in four (26%) say they are considering fixed-income funds for their next ETF purchase.

The survey finds that ETFs comprise, on average, almost 20% of ETF investors’ portfolios, and individual funds are held by investors for an average of 1.5 years.

The study reports that the cost of an ETF is the primary factor that matters to investors when choosing an ETF, followed by a fund’s performance history and the reputation of the ETF sponsor. When asked which specific components of cost are most important, respondents named the fund’s expense ratio first, followed by trade commission. In fact, 43% of investors say that the ability to trade a fund commission-free is important but not the only factor to consider when choosing an ETF. Premium and discount pricing, and a fund’s bid/ask spread, ranked third and fourth, respectively. —Nicole Bliman  

Who You Know: Existing relationships drive choice of IRA provider

Nearlyhalf (48%) of retirement plan participants who rolled balances into IRAs in the past two years chose their rollover institution based on whether they already had an account there.

This makes existing relationships the primary factor driving the choice of IRA providers, according to a study from the Spectrem Group. Other factors include offering a wide range of investment choices (29%), excellent customer service (28%), recommended by a financial adviser (27%), record of strong investment performance (27%), and low fees (26%).

Adviser relationships also play a key role in IRA rollover decisions. Depending upon their circumstances, at least 61% of investors involved a professional adviser in the process. Among job changers, for example, 61% used a professional adviser for rollovers. That percentage rose to 74% for those who were retiring and 77% for investors with large balances of more than $100,000.

Spectrem found that Fidelity was considered by 38% of all individuals looking to open an IRA account. Other providers considered by investors included Charles Schwab (25%), Vanguard (24%), ING (18%), and American Funds and J.P. Morgan Chase (tied at 15%). The providers that actually won the IRA accounts included Fidelity (30%), Vanguard (11%), American Funds (9.2%), Edward Jones (7.1%), and Morgan Stanley Smith Barney (6.6%).

One of the primary reasons these firms won the IRA accounts is that almost 70% of investors turn to their financial adviser for advice concerning their rollover. Not surprisingly, in many cases, the advisory firm (i.e., Morgan Stanley, Edward Jones) offers an IRA account solution of its own. American Funds, for example, is a popular fund family for advisers not affiliated with a large firm. It is likely that independent advisers assisted investors in choosing American Funds, according to Spectrem.

Another important selection factor identified by investors is “low investment management fees.” Sixty-nine percent of those rolling over an IRA look for low investment management fees. “Customer service from a person, not a VRS” is the most important selection factor for 70% of investors. To the extent that an individual is relying upon the adviser to choose a provider, it is not surprising that they already feel they have a person and not a system, Spectrem said. —Rebecca Moore

A Fresh Look: EBSA to re-propose definition of fiduciary rule

The U.S. Department of Labor’s Employee Benefits Security Administration (EBSA) will re-propose its rule on the definition of a fiduciary, a decision it says is due in part to requests from the public, including from members of Congress, that the agency allow an opportunity for more input on the rule.

Specifically, the agency anticipates revising provisions of the rule including, but not restricted to: clarifying that fiduciary advice is limited to individualized advice directed to specific parties; responding to concerns about the application of the regulation to routine appraisals; and clarifying the limits of the rule’s application to arm’s length commercial transactions, such as swap transactions.

Also anticipated are exemptions addressing concerns about the impact of the new regulation on the current fee practices of brokers and advisers, and clarifying the continued applicability of exemptions that have long been in existence that allow brokers to receive commissions in connection with mutual funds, stocks, and insurance products.

The agency said it will carefully craft new or amended exemptions that can best preserve beneficial fee practices, while at the same time protecting plan participants and individual retirement account owners from abusive practices and conflicted advice.

The extended time frame for input will supplement more than 260 written public comments already received, as well as two days of open hearings and more than three dozen individual meetings with interested parties held by the agency. The extended rulemaking process also will ensure that the public receives a full opportunity to review the agency’s updated economic analysis and revisions of the rule.

EBSA said it will continue to coordinate closely with the Securities and Exchange Commission and the Commodities Futures Trading Commission to ensure that this effort is harmonized with other ongoing rulemaking.

The new proposed rule is expected to be issued in early 2012. —PLANADVISER staff

Price Wars? Consistency beats out sympathy with pricing

Financial advisers who cut their fees during market downturns, a practice referred to as “sympathy pricing,” are hurting their businesses in both the long and short terms, a recent study found.

PriceMetrix, offering intelligence solutions for retail brokerages in North America, focused on transactional equity commissions in its study. It found that advisers not only lose money immediately when they cut their fees, but also have lower average returns on assets than other advisers and are unable to reset their prices as quickly when markets recover.

“As we’re seeing once again now, providing good advice to investors during volatile times is one of the most important services an adviser can offer,” noted Doug Trott, President and CEO of PriceMetrix. “Clients pay for the advice and experience of their advisers. They do not expect a discount when market performance is poor, any more than they expect to pay a premium when market performance is strong. As such, advisers should be confident charging a fair price in bad times, as well as good times.”

PriceMetrix’s database contains aggregated data on more than three million investors and 15,000 financial advisers. For the purposes of this study, the company looked at seven million equity trades over a three-year period ending in June 2011. PriceMetrix found that the average financial adviser cut his or her fees substantially during the market turmoil of 2008 and 2009. During this period, the average discount on commissions rose from 37% to 43%.

Advisers subsequently have raised their fees, with the average ticket size increasing from $224 to $231. On the other hand, price recovery has been fragmented as some advisers have raised rates more successfully than others. Just 13% charge full price while half of all advisers discount their commissions by at least 30%.

One of the most important, but often overlooked, aspects of an effective pricing strategy is how consistently it is applied, contends PriceMetrix. By a variety of measures, advisers who priced trades consistently over the three-year period ending in 2011 outperformed advisers who did not. Consistent pricers had a higher price to principal ratio of 1.13% compared to 1.04% for inconsistent pricers. They also had a higher average return on assets of 0.76% compared to 0.71%.

PriceMetrix also found that advisers who raised their commissions over the past three years actually improved their businesses and experienced less client attrition than advisers who did not raise their prices. While advisers as a whole reduced their average client load over the period, the data show that advisers who raised their prices by 25% or more lost fewer clients than other advisers with a decline of 6.1% versus 9.4%. Further, average production increased 12% for the group that raised prices, compared to 9% for advisers who did not raise their fees. Advisers who raised prices saw a 10% growth in the number of households generating $2,500 or more in revenue, compared to 6% for other advisers.

PriceMetrix believes that investment firms can help their advisers improve their pricing strategies by developing new price schedules, which are fair, clear, and rational. Firms also should work with their advisers to help them apply the new schedules. For example, firms can establish minimum ticket sizes or rewards good pricing practices. These steps can go a long way toward establishing and maintaining suitable pricing behavior among advisers.  —Nicole Bliman

Winner’s Circle: BofA wins suit regarding use of proprietary funds

A federal court has dismissed all charges against Bank of America for allegedly breaching its Employee Retirement Income Security Act (ERISA) fiduciary duties by using proprietary funds in its 401(k) plan investment lineup.

Several participants claimed that BofA favored its own funds and that the fees for the funds increased unreasonably after the company acquired Nations Bank.

Most of the claims were dismissed as time-barred under ERISA’s six-year statute of limitations on fiduciary breach claims. Even though the plaintiffs contended that a new violation occurred each month when participant contributions were deposited into the allegedly offending funds, the U.S. District Court for the Western District of North Carolina ruled that the conduct of which plaintiffs complain is the initial decision to invest in bank-affiliated funds, and cannot be recast as a failure to correct an omission. Further, U.S. District Judge Max O. Cogburn Jr. wrote, ERISA does not impose any obligation on fiduciaries to revisit their initial decision to include bank-affiliated funds in the plan lineup; rather, it prohibits and makes actionable a plan fiduciary’s decision to engage in a prohibited transaction.

Cogburn Jr. added: “the court can find no continuing obligation to remove, revisit, or reconsider funds based on allegedly improper initial selection. If that were the case, the limitations imposed by Section 1113(1)(a) would be meaningless and expose present plan fiduciaries to liability for decisions made by their predecessors—decisions which may have been made decades before and as to which institutional memory may no longer exist. Indeed, such a determination would turn Section 1113(a) on its head, making Section 1113(1)(b)’s open-ended period of repose for failure to correct omissions also applicable to failure to correct affirmative acts, which are clearly controlled by Section 1113(1)(a)’s close-ended period of repose.”

The court noted that, in 1999, a project team was formed by the Corporate Benefits Committee (CBC) to evaluate various issues relating to the 401(k) plan, including its selection and use of proprietary investment options, processes for paying expenses, and investment performance and fees. The team found that the plan’s procedures for selecting and monitoring investment options complied with fiduciary standards, that the performance and expenses of the mutual funds in the 401(k) plan’s lineup were reasonable, and that the administrative expenses paid by the plan complied with all regulatory requirements.

According to the opinion, since at least 2000, 401(k) plan participants were provided with disclosures about the plan, including the funds included in the plan and related fees. In addition, participants in the plan receive copies of the summary plan description (SPD) when they become eligible to participate in the plan, and periodically. Since at least May 2000, the summary plan description has consistently set forth a description of each of the funds. Several SPDs also advised participants that “Banc of America Advisors, Inc., an affiliate of Bank of America, N.A., performs investment advisory and other services for Nations Funds, and receives fees for such services.”

On their claim as to the Columbia Quality Plus Bond Fund, the only bank-affiliated fund added to the plan’s lineup within the six-year period immediately preceding the filing of the initial complaint, Cogburn Jr. found none of the plaintiffs actually participated in that fund; therefore, they lack standing to pursue a claim.

The case is David, et al. v. Alphin et al. —Rebecca Moore

A Clear Picture: DoL discusses participant fee disclosure regs

Summarizing participant fee disclosure regulations earlier this year, speakers during a Department of Labor Webcast discussed the two types of disclosures required by the new rule: automatic and on-request. Automatic disclosures must be provided annually and at least quarterly. There are two types of annual disclosures: plan-related information and investment-related information. Investment-related information must be provided on or before the date of first ability to direct investment and at least annually thereafter.

Plan-related disclosures must include: general plan operational and identification information; explanation of administrative expenses; explanation of individual expenses; circumstances under which participants and beneficiaries may give investment instructions; limits/restrictions on transfers; plan provisions on voting, tender, and similar rights; identity of designated investment alternatives and managers; description of any brokerage window or similar arrangement; explanation of any administrative expenses that may be charged on a planwide basis; basis on which such charges will be allocated among accounts; and explanation of any individual expenses that may be charged against participants’ or beneficiaries’ accounts.

Investment-related information should be provided regarding each designated investment alternative, but not investments selected through a brokerage window. It must include information essential for workers to consider in evaluating their investment choices, not just fee and expense information. It must be in a comparative chart or similar format. A model comparative chart is in the appendix to the regulations.

Investment-related information should include: performance data; benchmark returns over comparable periods; fee and expense information; total annual operating expenses; shareholder-type fees; a glossary; and a Web site address that contains fund information.

At least quarterly, sponsors must provide a statement of fees actually­ charged against participants’ or beneficiaries’ accounts and, if applicable, explanation of payment of a plan’s administrative expenses from annual operating expenses of designated investment alternatives. This information may be combined with quarterly benefit statements.

Disclosures that must be provided on request include prospectuses or similar documents for investments not registered with the Securities and Exchange Commission (SEC); financial statements or reports, if provided to the plan; and a statement of the value of a share or unit in each designated investment alternative and valuation date

Specific Situations

Michael Del Conte, Employee Benefits Law Specialist with the Office of Regulations and Interpretations in the Division of Regulations, noted a plan sponsor may use providers’ assistance with providing participants fee information. Under the innocent fiduciary provision of the regulations, the sponsor will not be held liable for incomplete or inaccurate information provided by a service provider if the sponsor used the information reasonably and in good faith in disclosures to participants.

In addressing the question of whether a sponsor must integrate investment information from different vendors in a single chart, or if it can use separate charts, Del Conte noted that nothing in the regulations requires the comparative chart to be laid out in a certain way. The model provided by the DoL lays the information out by asset type, but sponsors can lay them out by provider. The key is to present it in whatever way is best for participants, Del Conte said, but he added vendors cannot send their own charts to participants separately; all charts must arrive at the same time in the same envelope, and they also must be comparable.

In addressing wrap fees—a charge put on top of fees for investments to pay for other services—Del Conte says he has seen charges added to underlying investment fees to give a total annual investment expense to participants, but they also can be reported separately as administrative fees.

For the Web site required by the regulations to be provided for participants, Del Conte said a plan can set up its own Web site, which includes content from other sources, or a third party can set up the Web site.

Jeffrey J. Turner, Acting Deputy Director of the Office of Regulations and Interpretations, explained that, if there is a change in plan-related information after the disclosure is made, sponsors must notify participants at least 30 and no more than 60 days from the change. For investment-related information, the requirement is at least 30 and no more than 90 days.

Turner noted brokerage windows are not subject to investment-related disclosures but are subject to expense disclosures, which includes the general cost of setting up the brokerage window, an annual fee, plus commissions.

Turner told attendees the comparative chart model provided by the DoL is not required but, if used, the sponsor will be considered compliant with the required format.

On the selection of benchmarks for the plan funds, Turner noted that, if the fund tracks a major index, selection of the benchmark is easy but, if the fund holds a combination of asset types, as long as the plan sponsor complies with the general benchmarking requirement, it is not precluded from including other benchmarks, blended in same ratio with fund, to match the composite.

The regulations include detail on benchmarking for annuities and fixed-income products.

The applicability date of the participant fee disclosure regulations is the first day of the plan year that begins on or after November 1, 2011. For calendar year plans, that means they would be applicable on January 1, 2012.

The DoL has published special Transition Rules, which provide that initial disclosures may be made by the later of 60 days after the plan’s applicability date or 60 days after the effective date of the regulations. The first quarterly disclosures may be made no later than 45 days after the end of the quarter the initial disclosures are furnished. For example, with calendar year plans, the first comparative chart must be furnished by May 31, 2012, and the first quarterly disclosure must be furnished by August 14, 2012. —Rebecca Moore  

Bigger Books: Number of RIAs declines, yet total AUM increases

An annual report examining SEC-registered investment advisers found that, although the total number of RIAs declined for the first time since 2001, the total assets under management (AUM) rose by nearly 14%.

The Investment Adviser Association (IAA) and National Regulatory Services (NRS) issued their 11th annual report, “Evolution Revolution,” examining trends of the investment advisory profession by looking at annual updates filed by investment advisers registered with the Securities and Exchange Commission (SEC). The 2011 report is based on information on file with the SEC as of May 1, 2011.

This year’s report notes that the total number of SEC-registered investment advisers (RIAs) declined from 11,643 in 2010 to 11,539 in 2011. While relatively small, this is the first annual decrease in the number of investment advisers since publication of the report began in 2001. On the other hand, total assets under management (AUM) reported by all investment advisers on May 1, 2011, were $43.8 trillion, representing a 13.7% increase from the $38.6 trillion in AUM reported in 2010. This is the highest level of total AUM ever reported.

Consistent with previous years, the 2011 report confirms that a relatively small number of large investment advisory firms manage a high percentage of total AUM. The 78 largest advisers (i.e., those that manage $100 billion AUM or more) managed more than half (50.9%) of total AUM. Similarly, the 565 advisers with $10 billion AUM or more reported managing 84.4% of all assets.

The report emphasizes that the vast majority of SEC-registered investment advisers are small businesses. In 2011, 81.2% of advisers reported managing less than $1 billion AUM, and 41.3% reported managing less than $100 million AUM. Almost half of all advisers (49.8%) reported fewer than five full- and part-time, non-clerical employees. More than two-thirds of all advisers (68.8%) employed fewer than 10 full- and part-time, non-clerical staff, and more than 9 in 10 (90.6%) employed fewer than 50. —Nicole Bliman

Turned Down: Appellate court rejects another revenue-sharing case

Another plan sponsor has prevailed in a revenue-sharing case—and at the appellate court level.

This time the case was Loomis v. Exelon, a case argued before the 7th U.S. Circuit Court of Appeals, which had previously weighed in on the case that appears to be setting the tone in most of these cases, Hecker v. Deere & Co. In Loomis, Exelon employees had argued that the company breached its fiduciary duties to its 401(k) by providing investment options requiring the payment of excessive fees.

Here the 7th Circuit noted that “the district court decided that the current suit is a replay of Hecker and dismissed it on the pleadings,” and, despite some discussion of the issues, upheld the lower court’s dismissal—with prejudice—of the case. Writing for the court, Chief Judge Easterbrook concluded, “Unless Hecker is to be overruled, our plaintiffs cannot prevail”—and was clearly in no mood to overrule its own determination in the Hecker case.

The Department of Labor had argued in a friend of the court brief that, in dismissing the Exelon employees’ Employee Retirement Income Security Act fiduciary duty claims, the trial court required an “unduly high pleading standard” not contemplated by ERISA. Solis’ also contended the lower court misread the 7th Circuit’s ruling in Hecker.

Exelon Offerings

In this particular case, the Exelon plan offered 32 funds, 24 of them mutual funds open to the public, with expense ratios ranging from 0.03% to 0.96%. According to the court, the plaintiff-participants contend that the plan administrators violated their fiduciary duties under ERISA by offering “retail” mutual funds, and in “requiring participants to bear the economic incidence of those expenses themselves, rather than having the Plan cover these costs.” Here the court noted that “all of these funds were also offered to investors in the general public, and so the expense ratios necessarily were set against the backdrop of market competition.” Additionally, the 7th Circuit was persuaded that participants had available a “wide range” of options. The court restated its holding in Hecker, that “nothing in ERISA requires every fiduciary to scour the market to find and offer the cheapest possible fund.”

Regarding the inclusion of those retail funds on the menu, the court noted that “both Exelon and the funds distribute literature and hold seminars for the participants, educating them about how the funds differ and how to identify the low expense vehicles. Plaintiffs do not contest the adequacy of the Plan’s and the funds’ disclosures. What plaintiffs contend instead is that, if a pension plan offers only ‘institutional’ vehicles, fees will be lower on average, and that participants tempted by a high-expense fund might save.”

The 7th Circuit did delve into some new waters regarding the motivations of the plan sponsor in offering those retail funds, but ultimately noted that “there is no reason to think that Exelon chose these funds to enrich itself at participants’ expense. To the contrary, Exelon had (and has) every reason to use competition in the market for fund management to drive down the expenses charged to participants, because the larger participants’ net gains, the better Exelon’s pension plan is. That enables Exelon to recruit better workers, or reduce wages and pension contributions without making the total package of compensation (wages plus fringe benefits) less attractive.” The court went on to assert that “competition thus assists both employers and employees, as Hecker observed,” a finding it held in contrast with plaintiffs in an 8th Circuit case involving Wal-Mart employees where it was alleged that the plan sponsor limited participants’ options to 10 funds as a result of kickbacks. “Nothing of the sort is alleged in this case,” the 7th Circuit justices noted.

The Exelon ruling included a discussion of the relative advantages of retail mutual funds compared with “institutional” offerings that might not be as liquid and/or transparent, noted that the expenses of those retail funds in the Exelon plan were lower than averages provided by the Investment Company Institute (ICI), and also wondered aloud “why mutual funds would offer lower prices just because participants in this Plan have pension wealth that in the aggregate exceeds $1 billion.”

Regarding an alternative pricing scenario put forth by plaintiffs, the court cautioned that “A flat-fee structure might be beneficial for participants with the largest balances but, for younger employees and others with small investment balances, a capitation fee could work out to more, per dollar under management, than a fee between 0.03% and 0.96% of the account balance.”

As for whether the employer was under some kind of obligation to underwrite the plan fees, the court said “ERISA does not create any fiduciary duty requiring employers to make pension plans more valuable to participants. When deciding how much to contribute to a plan, employers may act in their own interests.”

Ultimately, the 7th Circuit held that “Exelon offered participants a menu that includes high-expense, high-risk, and potentially high-return funds, together with low-expense index funds that track the market, and low-expense, low-risk, modest-return bond funds. It has left choice to the people who have the most interest in the outcome, and it cannot be faulted for doing this.” —Nevin E. Adams

More than a Third of Retirees Receive Income from Annuities

According to a recent LIMRA study, 35% of all retirees receive income from an annuity, and the likelihood of taking income from an annuity increases with age. Only 19% of retirees younger than age 65 receive income from an annuity, but the number jumps to 49% when looking at retirees ages 75 to 79. About a third of retired households with incomes less than $75,000 rely on income from an annuity; for retired households with incomes of more than $75,000, the percentage increases about five points. Only
one-fifth of retirees who are receiving income from an annuity say they have received it from an immediate annuity. The study found that all other annuity income recipients are taking withdrawals from their deferred annuities. —Tara Cantore

Don’t Worry, We’re in Good Hands: Study likens bank traders to diagnosed psychopaths

Research from a Swiss university has found that bank traders are more prone to risky and manipulative behavior than diagnosed psychopaths­. 

With the world strapped into the roller-coaster ride known as the “stock market,” it would be comforting to know that our economy is being looked after by steady, reliable individuals.

Alas—this does not seem to be the case.

According to a study conducted by researchers at the University of St. Gallen in Switzerland, financial traders are more uncooperative than psychopaths and have a greater tendency for risk-taking.  In a game simulation as part of the research, a group of 28 traders cared more about beating the competition than bringing in the highest score.

“Traders go out of their way to destroy the competition, even if they don’t get any economic benefit as a result,” says Thomas Noll, who conducted the research. Speaking to German newspaper, Der Spiegel, Noll commented that they behaved as though their neighbor had the same car, “and they took after it with a baseball bat so they could look better themselves.”

Comforting Thought?

“Naturally one can’t characterize the traders as deranged,” Noll told Der Spiegel, “but, for example, they behaved more egotistically and were more willing to take risks than a group of psychopaths who took the same test.” —Nicole Bliman