Recently, I reviewed the investment options available in a mid-size 401(k) plan. It was the usual fare: mostly high expense ratio, actively managed funds which historically underperformed their benchmarks. There was one index fund in the mix, which the plan administrator proudly pointed out to me. It was the Dreyfus S&P 500 Index Fund (PEOPX).
I checked the data on this fund from the Dreyfus web site. Here's what I found:
The fund has over $2.4 billion in assets. It has total expenses of 0.50%, including a management fee of 0.25% and a "service fee" of 0.25%.
The goal of this fund is simply to track the performance of the S&P 500 index. How difficult can this be?
Quite difficult, when you have an expense ratio of 0.50%.
The fund underperformed the index by 0.42% in the last year; 0.38% over 3 years and 0.46% over 10 years.
Expense ratios can clobber returns.
Since all S&P 500 index funds have the same goal -- tracking the returns of the S&P 500 index -- it would make sense to purchase the one with the lowest expense ratio. For example, Fidelity's Spartan 500 Index Fund -- Investor Class (FUSEX) has an expense ratio of only 0.10%. The minimum investment is $10,000. Most 401(k) plans qualify for the purchase of Fidelity's Spartan 500 Index -- Advantage Class (FUSVX) which requires a minimum investment of $100,000. This fund has an expense ratio of only 0.07%.
The Investor class shares underperformed the S&P 500 index by 0.03% in the last year; 0.02% over 3 years and 0.09% over 10 years.
Huge difference compared to the Dreyfus S&P 500 index fund.
Allan Roth raised some troublesome issues with high expense ratio index funds in an "Open Letter" he wrote to SEC Chair Mary Schapiro.
Roth had proposed to the Chairman of the Dreyfus board that he pursue a tax-free merger of the Dreyfus S&P 500 index fund with a fund tracking the same index, but with a third of the costs. He noted that the merger would guarantee higher returns to shareholders of the Dreyfus fund. The Board turned down his proposal.
Roth questioned whether the directors of this Dreyfus fund violated their fiduciary duty by turning down an option that would have guaranteed their shareholders higher returns. He further inquired whether the fund had an obligation to disclose to its current and new shareholders the rejection of his proposal.
Whatever the answer to these questions may be, about this I have no doubt:
A plan sponsor of a 401(k) plan is vulnerable to a breach of fiduciary duty lawsuit by plan participants if it includes high expense ratio index funds as investment options, when lower cost ones are readily available.
Here's a more challenging issue:
Why is $2.4 billion invested in the high expense ratio, underperforming Dreyfus S&P 500 index fund, when lower cost, better performing, comparable funds are readily available?
Check your 401(k) plan options. If you have a high expense ratio index fund, complain to your plan administrator.
The irony of all this is that all 401(k) plans should consist only of pre-allocated, globally diversified portfolios of low cost, stock and bond index funds, passively managed funds or Exchange Traded Funds.
But that's another story.
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