Fidelity, Vanguard fee arrangement causes stir in the 401(k) industry

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Fidelity’s move to charge new 401(k) plan clients (with $20 million or less in assets) a 0.05% fee on any Vanguard funds held in their retirement plans has raised a few eyebrows in the industry, causing concern retirement fee arrangements might become the new norm.

The concern is due, in large part, because it isn’t “normal to have one single fund manager singled out like this,” says Jim Keenehan, senior consultant for AFS 401(k) Retirement Services.

Many in the industry don’t buy Fidelity’s explanation about why it decided to single out Vanguard – leveling fees vs. a deep rivalry between the two companies and a fight for market share. Many plan sponsors worry that other record keepers will follow suit, limiting the investment options employers are able to offer employees through their workplace 401(k) plans.

Nicole Abbott, director of communications for Fidelity Institutional and Fidelity Investments, said in a statement that, “Fidelity requires all fund families to compensate us for the shareholder and administrative services which we provide on their behalf. A small number of fund families have not compensated Fidelity for certain services and this pricing change is designed to address that disparity with the intention of providing fairness across all of our business relationships.”

She adds that Fidelity isn’t removing any fund families from its platform but it is requiring that all fund families compensate Fidelity for their services to “remain in good standing. This is not a distribution or revenue sharing fee; this fee is for administrative services that we are not compensated for.”

The fee will be assessed against the plan sponsors who hold Vanguard assets.

“I was very glad to see Fidelity is going to be implementing this without any impact on plan participants at all. The 0.05% will be directly billed to the plan sponsor vs. passing that through to plan participants by way of an additional asset charge. I like that,” says Keenehan.

He believes, however, that the fee will make using Vanguard funds less desirable for new Fidelity clients. It changes the conversation a bit.

“It is no coincidence that Fidelity lowered the fees on its own suite of passive or index funds so I think this change is also going to have an impact of opening the door a bit on the Fidelity platform for Fidelity to win back some of the market share they have been losing so rapidly to Vanguard. Vanguard is just dominating the investment world at this point,” Keenehan says.

Fidelity lowered its fees on stock and bond index mutual funds and sector exchange-traded funds last year. The Fidelity website shows a comparison between its own index and exchange-traded funds vs. those of similar funds managed by Vanguard and highlighted that 28 of 29 index funds and sector ETFs had lower expense ratios than their Vanguard counterparts, starting as low as .035%.

Kathleen Connelly, executive vice president of client experience and relationship management at Ascensus, says that her company looked at Fidelity’s decision with some interest.

“From our perspective and our own pricing methodology, we have made deliberate decisions not to change the fees based off the investments in the plan. So, one of the interesting things about what Fidelity is doing is they have one position for a plan of $5 million and a different position for one with $30 million. At Ascensus we made decisions that the plan lineup and the size of the plan shouldn’t impact the pricing if all other features and offerings otherwise remain the same,” she says.

She adds that it is important for Ascensus and its partners to ensure that plans under $20 million are not disadvantaged and have the same offerings as larger plans.

“If the plan has 200 participants or 500 participants in it, the cost for us to pick up the phone is still the same. If the same plan has average balances of $10,000 or $100,000, the statement production for us is the same. So as a record keeper, we’ve made decisions in our fee-based business not to allow the investment lineup to impact our costs,” Connelly says.

Vanguard partnered with Ascensus in 2011 to launch Vanguard Retirement Plan Access, a 401(k) retirement plan for small businesses. In the arrangement, Vanguard offers a bundled 401(k) plan service for small companies that combines Vanguard’s low-cost investment options and indexing expertise with the small-plans recordkeeping expertise of Ascensus, a leading record keeper and administrator of retirement plans.

“They were clear with us that we were looking to be a disruptor in the small end of the market and to bring pricing benefits down market. One of the attractions of the relationship is we shared that same philosophy with them,” Connelly says.

Fidelity says that it handles administrative and shareholder administrative services on behalf of Vanguard and all other fund companies on its platform, including fund setup, transfers, share class conversions, fund closings, communications, trading cash settlement, pricing and account valuation, dividends and distributions, reconciliation, statements and confirmations, 22c-2, tax reporting, e-Delivery, disclosures and sales reporting.

“On top of that, Vanguard has a requirement that plan level trading activity (large trade notifications) be submitted by 3 p.m. EST, or an hour prior to market close. This has created increased complexity for Fidelity and our Plan Sponsors in that we have had to implement an earlier daily cut-off process, ensuring the trade notifications will be analyzed, reviewed and submitted to Vanguard – minimizing any trades being rejected,” Abbott says.

“Each morning, any actual Vanguard fund trading activity that is off from the prior submitted trade notifications requires dedicated Fidelity resources to work with Vanguard to analyze those trades and determine whether the variance was plan-driven or participant-driven activity. In addition to the manpower the above large trade notification and trade analysis requires, Fidelity has had to spend a significant amount on technology in order to support these custom services.”

Connelly says that she wouldn’t be surprised if other record keepers follow Fidelity’s lead in how it is now treating Vanguard funds on its platform but “we will not be one of them.”

Ascensus offers a fee-based model and has for more than a decade. In her career, Connelly says she has worked at shops that focused on larger plans and ones that focused on smaller plans. It is easier to go from small market to large market than bring what was built for the large market, down market, she says.

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