The WSJ on Index Funds in 401(k) Plans

by: Kevin S. Price

Over the weekend, Eleanor Laise published an enormously important Wall Street Journal story on the (slowly but noticeably growing) presence of index funds in 401(k) plans. As longtime readers know, this subject resonates in a big way here at Interlake. Here's the crux of the story:

Employers are making it easier for workers in 401(k)s to own low-cost index funds and exchange-traded funds, a move that has implications for the mutual-fund industry.

As it stands, roughly 90% of the $1.5 trillion in 401(k) and other defined-contribution assets in mutual funds are in actively managed offerings. This is the case despite clear evidence from studies that index funds tend to outperform their actively managed rivals.

The stodgy 401(k) world won't change strategies overnight. Fund companies won't easily relinquish their active-management fees, which tend to be higher than those charged on index-tracking products, especially at a time when rocky markets are pinching profits. And actively managed funds tend to do more "revenue sharing," which involves fund companies making payments to plan administrators.

While total index mutual-fund assets jumped 84% over the past six years, the funds grew at a substantially slower pace inside defined-contribution plans.

Our view is that 401(k) services are more sold than bought, and that the sellers have long had self-interested reasons to obscure plans' true costs, stuff investment menus full of sub-optimal (often but not always proprietary) funds, and engage in various forms of "move along...nothing to see here."

It is long past time for service providers, sponsors, and participants to insist on fiduciary principles and practices. In most conventional asset classes, excellent index-based mutual funds (and/or ETFs and collective funds) are readily available. Because such funds don't engage in "revenue-sharing" (a euphemism for concealing and often inflating the costs of administrative services), their use will require greater transparency. But then that's exactly the point, isn't it?

And speaking of transparency, it's great to see Matt Hutcheson and our friends at BrightScope get some excellent press in the Laise piece. These guys aren't at the leading edge of the transparency movement. They are the leading edge.

Full disclosure: Interlake is proud to be the investment advisor to two of the plans mentioned in this article.


Eleanor Laise, "More Index Funds Sought for 401(k)s," Wall Street Journal, July 18, 2009