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3 responses to “Due Diligence has New Vanguard “Low-Cost” Product Opening to Mixed Reviews”

  1. Robert Lee

    Very insightful analysis here, Chris. I have been wise to Vanguard’s use of non-Admiral/Signal/Inst’l shares on their own platform and have perceived the use of retail shares to be less than “fee neutral”. Your shining light on this is helpful, along with pointing out that the product may not be much less costly compared to other bundled providers when services to plan sponsor and participants are dialed up.

    Nice piece! Thanks!

  2. Linda Wolohan

    In an effort to help present a balanced look at how Vanguard approaches revenue sharing, below is our position on some of the statements that we feel were misinterpreted in this piece.

    Article: Leidy, though, analyzed the example in the press release and discovered revenue sharing accounted for 10 basis points. “In actuality the fee is 42bps,” he points out. “If a sponsor/advisor were to select Admiralty/Signal shares, additional ‘out-of-pocket recordkeeping fees’ would apply.”

    Simply stated, what Mr. Leidy describes as “revenue sharing” is actually Vanguard’s system of attributing a portion of the expense ratio (currently 10 basis points) of the Investor share class of Vanguard funds in plans that we recordkeep to the recordkeeping and administrative services that we provide. These credits are used to offset the cost of those services and they are clearly disclosed. They do not represent an additional payment above the expense ratio of the Investor share class funds. In the example you have used, using the lowest-cost share classes would yield an all-in fee that is 33bps—not the 42bps cited in the article.

    To explain how that works, here’s some additional background. Historically, Investor Shares of Vanguard funds have been the primary share class used by our full-service recordkeeping clients. This is because many of our plan sponsors had elected to have their plans pay for recordkeeping services through asset-based fee structures, and that’s still primarily the case today. However, because some plan sponsors wanted to move to fixed out-of-pocket fee structures, we now provide sponsors and their committees with increased flexibility in determining how their plans pay for services. We have simplified our eligibility criteria so that all plans have access to lower-cost share classes, which for our 401k service for small businesses are Signal Shares for Vanguard index funds and Admiral Shares for active funds. The share class that a sponsor chooses does not impact a plan’s all-in fee; it simply provides flexibility in how a plan pays for recordkeeping services.

    If a plan uses Investor Shares, it receives credits toward recordkeeping costs. Conversely, plans using the lower expense ratios of Signal and Admiral share classes don’t receive a credit toward the cost of recordkeeping and so an out-of-pocket hard-dollar charge—either paid by the participant or by the sponsor—is necessary to cover the cost of recordkeeping and other services. As a result, plans can choose to pay for plan services among the following structures:
    1) Through asset-based fees.
    2) Through direct participant- or sponsor-paid fees.
    3) Through a combination of asset-based and direct fees.

    Again, regardless of the structure the client chooses, the all-in-fee of your example would be 33 bps, not 42 bps. The primary difference is based on how those fees are paid.

    Article: The larger question is Vanguard’s casual acceptance of revenue sharing to give the impression of lower fees… AND… By lauding a “low-cost” product where that “low-cost” is predicated on revenue sharing, Vanguard risks exposing 401k plan sponsors to increased fiduciary liability.

    Once more, Vanguard’s recordkeeping credits are not revenue sharing. They are used to offset the cost of the administrative services that we provide when sponsors choose to use Vanguard Investor share class funds. Furthermore, the use of recordkeeping credits does not materially impact a plan’s all-in fee—it simply provides clearly disclosed flexibility to sponsors. The credit cannot be used by sponsors to pay third parties or financial advisors. It may only be used to reduce the annual out-of-pocket plan fee and participant fee. In instances that Vanguard receives revenue sharing from non-Vanguard fund companies, it is applied toward the cost of recordkeeping the plan. Vanguard always discloses these amounts to plan sponsors.

    As you may know, historically there has not been a requirement to disclose revenue sharing payments—and won’t be until Department of Labor regulations become effective later this year—so some plan sponsors may still be unaware that their explicit recordkeeping fee is being highly subsidized by payments from third parties. In contrast, even in the absence of a regulatory disclosure requirement, Vanguard has long proactively and routinely disclosed plan fees in a comprehensive manner. This includes our all-in fee disclosure, which we began using in the late 1990s.

    To reiterate, plans will have approximately the same all-in fees whether the plan uses the lowest-cost shares available or our already low-cost Investor Shares, with any slight variation depending on the funds offered in the plan line-up.

    Because of Vanguard’s transparent approach on how revenue sharing is applied, plan sponsors are fully aware of all fees and how the cost impacts their participants, which helps them fulfill their fiduciary obligations of determining the reasonableness of plan fees.

    Linda Wolohan

  3. Jonathan Leidy

    Well… let me begin with a few acknowledgments.

    1. Vanguard’s offering, as stated in the article, stands head-and-shoulders above the bulk of the competitors in the $0-20MM space.
    2. In a world where expense control is paramount, Vanguard’s platform affords sponsors a reasonably transparent opportunity to exert leverage.
    3. As fiduciary consultants to retirement plan sponsors, we are big Vanguard devotees and use their funds copiously when building sponsor menus.
    4. I realize this article is roughly a month old, and hence maybe “old news” to everyone, but it has unfortunately taken me this long to plug back into it.

    Those things aside, I appreciate Linda’s comments above and by no means was attempting to blast Vanguard with my commentary. I was simply trying to point out the following:

    1. Whether you call it revenue sharing or not, the concept is the same. Revenue is collected by the fund company and is subsequently redirected to offset administrative expenses associated with the plan.
    2. Although this is a ubiquitous practice in the retirement plan industry (and it is completely acknowledged that sponsors can elect the more transparent Admiral/Signal options), I find the whole notion of fee credits to be inherently less than transparent and, in turn, somewhat odious.
    3. From a pure business perspective, I don’t fault Vanguard for being in the fee credit game. It’s likely that a lot of revenue would be left on the table, if they didn’t offer fee credit opportunities. However, taking a hard-line stance against revenue sharing (and any other closely related practices) would be both in the best interest of participants/sponsors, in my opinion, as well as in keeping with the moniker Vanguard.
    4. Admittedly devoid of all the facts, I still question the math engendered in the Vanguard brochure. It appears that Vanguard has selected the absolute lowest cost example possible, which, although not unscrupulous, may not be a reasonable portrait of the cost engendered in providing a plan to the average plan sponsor. Specifically, if a plan sponsor were to select any active funds, Vanguard or otherwise, the costs would rise. Similarly (and I am extrapolating here), it seems unlikely that Vanguard would, as an example, be willing to record keep the same $5MM plan cited in the example for 10bps, if the sponsor were to have 1,500 participants instead of the referenced 100.
    5. Fee credits breed cross-subsidization… period. In this way, I suppose we are more apostles of “fee purity” as compared to the recently-popularized (and equally noteworthy) notion of “fee transparency.”

    That’s all. Linda and Vanguard, please take no offense. In a cupboard of largely rotten vittles, you are indisputable “good eggs.”

    Portico Wealth Advisors

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