It may no longer be enough for a mutual fund company to supply defined contribution plan participants with a trusted brand name, a diversified portfolio of funds, strong performance and a glossy investment kit.
Plan sponsors are beginning to require mutual fund companies to include investment advisory software and telephone services in their plans so that employees can make better informed choices about their 401(k) investments. In fact, in the past few months, employers have begun making these stipulations in requests for proposal guidelines, according to industry executives.
Some of the leading mutual fund companies began offering such advisory services to their defined contribution sponsors this past spring. Merrill Lynch of New York, State Street Global Advisors of Boston, Credit Suisse Asset Management of New York, Fidelity Investments of Boston and Aetna Life Insurance and Annuity Company of Hartford, Conn. announced 401(k) advisory services in May and June (MFMN 4/26/99, 5/17/99). Trust Company of the West of Los Angeles and Conseco Capital Management of Carmel, Ind., are also now developing such services.
This is just the beginning of a 401(k) advisory trend, according to Ted Benna, the developer of 401(k)s and president of the 401(k) Association, an advocacy organization in Bellefonte, Pa. A number of other leading mutual fund complexes are also setting up 401(k) advisory services, he said.
There are a number of reasons mutual funds are helping defined contribution investors determine asset allocations, savings rate and retirement goals as well as providing detailed performance data and information on underlying holdings.
One major motivator is the fact that the 401(k) market continues to be very lucrative and mutual fund companies are striving to distinguish themselves in this highly competitive market.
Today's $1.3 trillion in 401(k) savings will grow 13.5 percent annually to reach $2.4 trillion five years from now, according to the Spectrem Group, a mutual fund research organization in San Francisco.
Fund companies are also racing to give 401(k) advice because it enables them - for the first time - to communicate directly with plan participants. This gives fund complexes a better chance of retaining assets and preventing them from being rolled over to other investment companies, said Jeff Maggioncalda, chief executive officer of Financial Engines of Palo Alto, Calif. Financial Engines is one of a handful of software companies providing investment advisory services to 401(k) providers.
Right now, 401(k) retention rates are very low. Plan providers succeed in retaining only 11 percent of funds that are rolled over each year due to job changes or retirement, according to Spectrum Group, a management consulting company in Oak Brook, Ill. (MFMN 5/31/99). This represents an enormous amount of business lost each year. In 1998, there were 10.5 million such distributions worth $288 billion, according to Spectrum. In other words, 401(k) providers lost $262 billion of business to competitors last year alone.
"If they are looking at 89 percent of their money evaporating, they are going to be desperately seeking ways to provide advice and to brand it so they can retain assets over time," said Mike Henkel, president of Ibbotson Associates of Chicago, which is also supplying 401(k) advisory software to mutual funds.
Aetna, which will introduce its 401(k) advisory services by the end of the year, hopes to eventually move from providing 401(k) advice to helping employees manage their money during retirement, said Shaun Mathews, senior vice president and product manager.
Mutual fund companies are now comfortable offering 401(k) advice because of a 1997 exemption to the Employee Retirement Income Security Act (ERISA) that allows mutual fund companies and plan sponsors to offer advice without incurring fiduciary liabilities.
The Department of Labor first issued an interpretive bulletin to ERISA in 1996, easing the way for mutual fund companies to provide more helpful, general information to 401(k) investors. The bulletin said mutual fund companies could provide retirement planning calculators, asset allocation models and general financial and investment information on such topics as risk, diversification and inflation. But the bulletin stopped short of allowing mutual funds to help investors make specific fund choices from their 401(k) plans.
That changed in 1997, when Trust Company of the West obtained an exemption to ERISA's prohibition against recommending specific funds because TCW agreed to hire an independent research company, Ibbotson, to develop software to do so. The arrangement relieved TCW and its plan sponsors of any fiduciary responsibility.
"TCW's approach has opened the door for providers to find ways of offering advice that benefit participants and are neutral for the provider," said Jeff Close, a consultant with Spectrem Group.
Besides Ibbotson and Financial Engines, 401(k) Forum, a registered investment advisor in San Francisco, and Standard & Poor's, the New York-based mutual fund tracking firm, offer investment advice to 401(k) providers.
To further strengthen its 401(k) capabilities, S&P acquired Rational Investors on July 6 for an undisclosed price. Rational Investors is a 401(k) software provider in Boston with eight mutual fund and money management firm clients.
"S&P's brand name is well-known and will enable our business to grow," said Francois Gadenne, president of Rational Investors, in a statement.
Morningstar of Chicago is also currently considering getting into the advice business. The company is in, "the earliest of exploratory stages," said Martha Dustin Boudos, director of marketing for retirement plan services for Morningstar.
Besides making relationships between 401(k) providers and participants more personal, providing advice can also motivate more employees to participate in their 401(k) plans and to invest a greater percentage of their salaries, industry executives said. Currently, only 15 percent of U.S. employees who are eligible to participate in their company's defined contribution plan do not take advantage of it, according to the council (MFMN 6/14/99).
State Street began offering advisory services to its defined contribution plan sponsors in March and since then, Reed Elsevier and Nissan Motors have signed up for the new service, said Ray Martin, a principal at State Street and head of State Street Global Advisory Services. Plan participants at these two companies have increased the percentage of their salaries they contribute by an average of two percent since March, said Martin. State Street considers this increase a significant amount and testimony to the value of 401(k) advice, he said.
Although TCW will not introduce its 401(k) advisory services until the fall, it expects participants to increase the amount they invest, said Sherri Grabot, senior vice president of TCW's defined contribution group.
"Right now, most people default to six percent savings because most employers match contributions of this size," Grabot said. This is an "arbitrary" way of investing and not the right amount for everybody, she said. "Once people understand the impact of their investments, I am fully convinced savings rates will go up."
Companies are also offering 401(k) advice because many participants are desperately in need of it.
"Investors certainly need education about how to allocate their money in a plan," said Benna of the 401(k) Association. "When they have 28 funds to choose from, the average investor feels helpless about understanding the differences, and they can become paralyzed."
