Is There a 401k Fee War Brewing?

One wonders why The Wall Street Journal chose February 2010 to write a story about a blog written in November 2009 by a start-up retail investing web-site? Could this be the start of a new 401k fee war?

On the face of it, this appears a non-story. kaChing.com is an internet investment adviser registered in only 18 states (see their Form ADV, Section 2 SEC Registration). Their “About Page” states the firm’s self-described mission is to provide “compelling alternative to actively managed mutual funds.” Clearly, kaChing.com has an agenda.

But so does the Investment Company Institute whose “job is to defend mutual-fund companies from criticism” according to The Wall Street Journal story (“How High Are Fees? Either 1.17% or 3.37%,” Wall Street Journal, February 12, 2010).

Still, why wait until now to bring up the three-month old blog?

Perhaps it’s because kaChing seems to possess an effective publicity machine. Viewers can count references to at least 19 separate articles mentioning the company on the firm’s web-site. Maybe on the heels of BrightScope’s release of its much discussed product (“BrightScope Talks About Its New 401k Fee Product,” FiduciaryNews.com, January 19, 2010) and the anticipated Supreme Court decision on the Jones vs. Harris case (“Is Supreme Court About to Mislead 401k Investors & Fiduciaries?” FiduciaryNews.com, September 4, 2009) there’s a growing bandwagon against mutual fund fees.

Andy Rachleff, President and Chief Executive Officer of kaChing and author of the blog (“Mutual funds and Their Unfair Fees – The Feeling’s Not Mutual!” kaChing.com, November 11, 2009) does raise some very valid points. For example, he joins the growing chorus against 12b-1 fees and other “marketing” fees, resurfaces the old complaint against (nearly extinct) soft dollar arrangements and repeats the lament of fee-only advisers in opposition to the conflict-of-interest ridden use of loads and commissions. Even the ICI can’t – and doesn’t – argue with these points. The mutual fund industry itself offers a heated debate between funds on these subjects. Mr. Rachleff merely provides more fodder for the pure no-load side of the debate.

And one can’t blame kaChing.com for bringing up the controversial issue of taxes. They didn’t start that. The SEC did several years ago when it required mutual funds to begin showing hypothetical tax costs in their prospectuses.

Even kaChing.com’s clear vested interest in managed accounts shouldn’t cause concern. After all, it’s long been known managed accounts have clear advantages over mutual funds. Perhaps about the only possible complaint one might have against kaChing’s efforts could be the fact that, according to its ADV Part II, its own fee can be as high as 3% – and that’s before adding the commissions and taxes it so eagerly adds to the average mutual fund expense ratio.

Of course, The Wall Street Journal does correctly point out three important distinctions between kaChing’s number and the ICI’s more generally accepted average mutual fund fee of 1.17%. First, kaChing includes a tax liability of nearly 1%, which really isn’t relevant for retirement plans and often is different for taxable investors even when they’re invested in the same fund. Second, kaChing cites trading costs as 0.20%, more than twice the 0.09% the ICI believes it to be. Finally, and perhaps of greatest concern, is the apples-to-oranges nature of the comparison. kaChing uses equal-weighted data while the ICI uses asset-weighted data. This means the ICI data more likely reflects the results of the average investor.

In the end, we need to read these blogs and stories with caveat emptor glasses – some might see the kaChing blog as nothing more than a high tech marketing piece designed to persuade investors to buy their product and we all know who pays for the Investment Company Institute.

The bigger question, however, remains, “How should a 401k fiduciary analyze mutual fund fees?”

With the DOL and the SEC only confusing matters by employing, perhaps, too simplistic a view on fees, maybe the best piece of advice comes from the DOL’s “A Look at 401k Plan Fees:” The ERISA regulator’s web-site reminds fiduciaries to “keep in mind that the law requires the fees charged to a 401(k) plan be ‘reasonable’ rather than setting a specific level of fees that are permissible. Therefore, the reasonableness of fees must be determined in each case.” Remember, unlike their higher cost counterparts (i.e., active funds), some 401k investors might not have considered the cheapest mutual funds (i.e., index funds) a reasonable investment option during the last decade (see “Does the ‘Lost Decade’ Signal the End of Passive Investing?” FiduciaryNews.com, January 5, 2010).