PART 5 (out of 10)

Most Expensive Funds

The remaining eight funds were too expensive, in my opinion. All five Lifecylce T. Row Price funds, Turner Mid-Cap Growth, Janus Mid-Cap Value and Davis NY Venture A cost over 1.0% total cost. At 1.35% Turner Mid-Cap Growth, the highest cost fund, would grow in somebody else’s pocket other than our employees. That fund was numero uno on the list for replacement.

If you invest in Turner by 2044 you will pay too much. You cannot ignore the math. 1.35% fee may sound reasonable, but over 30 years, the fee will diminish a nest egg by 18.85%.  Eighteen percent less money was too much for handholding and filling out enrollment forms. More important, it was not fair for some colleagues to pay three times more for Turner Mid-Cap than for Vanguard Extended Market Index. Will the participants know these cost differences?

Watch Out!

The lack of regulations for transparency speaks to the ethics in the industry. This practice was widespread including 401k plans. But the buck-stops-here—our committee demanded transparency. Most employer-sponsored retirement plans do not require transparency. It took two boards of education meetings, a special meeting and several oversight committee meetings to obtain the data I needed to create Table 2. The point is no matter how wonderful, insightful and clever George was in designing a new plan or how big and prestigious the consulting firm, it was the committee who calculated the total costs and required transparency.

Mercer Did One Thing Right—Include Index Funds

Using index funds for passive investing was not discussed in detail in this book. A list of my favorite books examining the advantages of the passive over actively managed strategy are in the reference section. For brevity, index funds are an ideal fit for retirement plans because they are broadly diversified in the major asset classes, are low-costs and easy to monitor.

Mercer was commended for offering four index funds out of 18 (Dreyfus S&P 500 Index, Dreyfus Bond Market Index, Vanguard Extended Market Index and the Vanguard Developed Market Index). In Mercer’s customized design for LAUSD they wrote: “Participants who prefer to construct their own portfolios have a choice of the four index and nine actively managed funds.”

The Dreyfus S&P 500 Index included revenue sharing which increased the cost. This original index was created and launched in 1976 by the legendary Vanguard founder, John Bogle. Revenue sharing was included in many mutual fund companies in addition to Dreyfus. Many industry consultants embraced index funds with one huge caveat—you guessed it—revenue sharing. Mercer selected the Dreyfus S&P 500 and the Dreyfus Bond Market Indexes to share revenue with AIG-VALIC.

The Dreyfus S&P 500 Index was used as evidence in the Daniel Hall and David Hamblen vs National Education Association (Largest teacher’s union in the country) class action suit of excessive 403b costs:

“…one option offered to Plan participants is a Dreyfus fund designed to track the Standard and Poor’s 500 stock index. The total operating expense for the Valuebuilder [NEA’s plan] Dreyfus stock index fund in 2006 was 0.30%. That is over three times the 0.09% operating expense on Admiral Shares in Vanguard’s 500 Index fund. Prudent fiduciaries do not select investment options costing three times more than a comparative product” (p. 29).

Was Mercer acting as a “prudent fiduciary?”

Share Classes Led to Revenue Sharing

Revenue sharing sounds great, if you are being shared with. Except there was one little secret–it’s shared between the fund company and the plan record keepers, the TPA. Learn which funds have revenue sharing by identifying their share class designation.

Share class is a classification system given to stocks and mutual funds. They are designated by letters of the alphabet: “A Shares,” “B Shares,” “C Shares,” “D Shares,” “E Shares” and “Z Shares.” Mutual fund A Shares, for example, have front-end loads (commission paid to the adviser on buying) while B Shares or C Shares have back-end loads (commissions paid on selling). Share classes pay the brokers, advisers, managers and the TPA (AIG-VALIC) compensation. Be aware not all mutual fund companies use the same share class definitions provided here.

I made this easy to understand by avoiding investments with share class designations in my portfolio. It’s too expensive. Look up the ticker symbol on Yahoo finance to see the share class. Don’t you want the fund which keeps earnings in your pocket? Choose investments which do not ding you every year with bloated charges. Vanguard and TIAA CREF do not share revenue, the primary reason why I used TIAA CREF for my 403b during my last six years of teaching. The employees we represent, as committee members, also deserve the same treatment.

What Happened to the Committee’s Recommendations?

Armed with the total cost information in Table 2, we proposed three fund changes to the selection of funds. The funds selected for removal were the most expensive (the expensive T.R. Price were part of a series of Target Date funds which required more time to find a lower cost replacement). It was the committee’s job to select the funds so we requested three individual funds be replaced:

Table 3

Asked to be Removed:                                              Replaced by:

1. Turner Mid-Cap Growth (1.35%)          1a. Dreyfus Mid-Cap Index PESPX (.65%)*
2. Janus Mid-Cap Value (1.07%)              2a. Pioneer Mid-Cap PYCGX (.84%)*
3. Davis New York Venture A (1.04%)      3a. Davis NY Venture Y DNVYX (.79%)

*From AIG-VALIC Initial Recommendations, page 2 of Investment Structure and Fund Line-up Recommendation Report for LAUSD Deferred Compensation Plan (July 2006).

 In part 6 released on Monday December 30, both LAUSD and the committee consultant push back against the committee’s suggested lower cost of ONLY three (out of the 18 funds) funds!