Funds With Revenue-Sharing Fees Can Be The Lowest Net Cost Option

An InvestmentNews article reminds us that plan sponsors can reduce the net cost of retirement plan investments through optimal handling of the non-investment-management related components of a mutual fund’s expense ratios, commonly referred to as “revenue sharing”. Astute plan sponsors and their advisors generally insist that their plan’s providers credit these “revenue-sharing” amounts directly back to the participants who invested in those specific funds, thus ensuring each participant pays only their pro-rata share of recordkeeping expenses. Our founder, Michael Montgomery, was interviewed for the piece.

Though many advisors and plan sponsors eliminate the excess revenue issue entirely by only utilizing the lowest expense “zero-revenue” fund share classes which do not contain any revenue sharing, the article correctly points out that due to pricing inefficiencies across share classes of some funds, the lowest overall expense share class does not always provide the lowest net investment management cost. Consider a typical example:

ABC Mutual Fund comes in two share classes (same fund, different expense ratios):

  • The lowest cost “zero-revenue” share class of ABC Mutual Fund has a 0.60% expense ratio. It credits back 0% revenue sharing, so its net cost is 0.60%.
  • The more expensive share class of the same fund has a total expense of 0.75% but credits back 0.25% of revenue sharing, resulting in a net investment cost of 0.50%. 

In this example, the more expensive share class had the lowest net investment cost.

Some recordkeepers handle this task seamlessly, but a number of major providers struggle with the execution. “Some may do the accounting on a daily basis while some may credit revenue based on which participants are in a fund at the end of the month or quarter.” Mr. Montgomery said when interviewed for the article. “Further, record keepers may only extend this service to plans of a certain size.

Theodore J. Schmelzle, JD, CIPP, Director of Plan Sponsor Services at Securian commented to MRPA, “Returning revenue sharing to participants on a daily basis benefits plans in so many ways – – using the lowest net share class, assisting plan sponsors with their duty to understand what is actually being paid, increasing performance and avoiding reallocation issues associated with ERISA ‘bucket’ accounts. It provides clarity and peace of mind to plan sponsors and advisors alike, greatly assisting in the ongoing fiduciary duty to monitor share class selection.” 

Plan sponsors should carefully consider the lowest net cost share class of a fund, and balance that consideration against other factors such as employee perceptions and recordkeeper revenue-crediting capabilities.