Index Funds & Fiduciary Care: Another Example of How Both Go Together

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Choosing passively managed funds is a step in the right direction. But as investors in two large retirement plans sponsored by their employers are learning, selecting the right index funds isn't exactly a walk in the park.

A trio of participants are jointly charging that Principal Financial Group's target-date funds used by 401(k) plans offered through Starkey Laboratories and Fleetcor Technologies feature underperforming and overpriced investments.

"Compared to marketplace alternatives, Principal's index funds deviated further from the benchmark index, and consistently had the worst performance even on a pre-fee basis," says the lawsuit, which was filed in the U.S. District Court for the Southern District of Iowa.

The investment vehicles in question are so-called hybrid target-date funds which present a mix of passively managed and actively run funds. As with proprietary index funds included by Principal that have produced lagging performance numbers, the suit contends that the fund provider did much the same with active funds included in both 401(k) platforms.

But active funds are one issue. As IFA has consistently documented over the years, passive management has a track record of giving investors the best chance to generate the best returns over time net of fees. A wealth of academic research supports our own studies. (See: Investment Management's Dirty Little Secret.)

With such an immense body of evidence, it only makes sense to assume that most advisors working with retirement plan sponsors already have plenty of forewarning about the risks of choosing actively managed funds.

But in this latest case involving retirement plans being sued by its participants, (Nelsen et al. vs. Principal Global Investors Trust Co. et al), the plaintiffs don't see investment pros running these investments as simply lacking knowledge. 

Instead, plaintiffs say Principal is clearly not acting "in accordance with their fiduciary duties." The suit alleges that the firm's poor decisions regarding underlying investments used in its target-date funds, highlighted by its selection of  index funds, weren't made with plan participants' best interests in the forefront.

Principal isn't alone in being sued by retirement plan investors. On the heels of that lawsuit being filed, a federal judge in California has granted preliminary approval for Allianz Asset Management of America to pay $12 million to settle 401(k)-related complaints.

Allianz – a part of Munich-based Allianz SE, which owns Pacific Investment Management Co. (PIMCO) – was being charged with not providing adequate investment alternatives to retirement plan participants, according to the Orange County Business Journal.

Another recent case involves participants in the $3.8 billion retirement plan offered through the University of Pennsylvania. Among other things, they're contending that those running the program breached their fiduciary duty by charging "unnecessary" fees while the portfolio "underperformed," according to the National Association of Plan Advisors.

The report details how the suit was dismissed last year and is now being appealed. It's also one of 17 lawsuits filed against university 403(b) plans since August 2016, notes the nonprofit NAPA.

Indeed, advisors at IFA are seeing a notable rise in sensitivities around fiduciary concerns in both for-profit and nonprofit retirement plan markets. As an independent registered investment advisor created to serve as true fiduciaries to individual investors and their families, we're finding increasing demand for our advisory services by enlightened sponsors of 401(k), 403 (b) and similar pension plans.

IFA is now working with more than 60 different retirement plans, helping both participants and plan sponsors tasked with running such investment platforms. Lawsuits like the ones involving Principal and Allianz just reinforce our contention that acting in our clients' best interests, whether it directly benefits us or not, is the most sensible and ethical way to recommend investments.

This is being provided for informational purposes only and is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, service, or considered to be tax advice. There are no guarantees investment strategies will be successful. Investing involves risks, including possible loss of principal. IFA Taxes is a division of Index Fund Advisors.