401(k) Plaintiffs' Attorneys are now Looking at QDIA Performance

401(k) and other participant-directed defined contribution (DC) plans must have a QDIA (Qualified Default Investment Alternative.) This is where contributions are invested for participants that do not make an affirmative investment choice.

There are several ways this can be done. Target Date Funds that are allocated based on age or expected retirement are the most popular option. Some QDIAs, by contrast, are an internally managed pool with a risk profile designed to meet all participants' needs. Regardless, most participants simply go into the QDIA... and stay there!

Some record keepers, however, in an effort to not have to send a bill, have taken an approach that may now be acutely problematic in the wake of the Cunningham v. Cornell decision.

Specifically, a record keeper manages the QDIA using mutual funds and CITs that rebate sufficient revenue to offset hard dollar fees. This revenue is often not disclosed on participant statements and thus shows $0 Administrative Fee. Et voila, no billed, hard dollar fees!

But we all know there is no free lunch. And record keeping is a necessary service that must be paid for.

Is the Fee Tail Wagging the Performance Dog?

The big "Cunningham question" for plans that use a pooled QDIA with mutual funds and CITs to offset record keeping fees is- Is the QDIA's performance being sacrificed by using high-fee, actively managed mutual funds and CITs? Further, is the investment strategy and its execution, usually by an investment consultant or OCIO, adding or destroying value?

It is quite possible this structure is far more costly than using low-fee Target-Date Funds and paying hard dollar record keeper fees. But it is difficult for DC plan trustees to know the answer, especially if only relying on the performance reports from the investment consultant or OCIO that manages the QDIA.

Three reasons why DC plan trustees will find it difficult to know the truth, which leaves them vulnerable to a lawsuit.

#1- Biased Performance Reports

When the ones who do the investing also provide the reports, it is an agency problem. This player-keeps-the-score conflict often results in rosier-than-reality performance comparisons. Strawman benchmarks, mis-weighted benchmarks, and other methods create the illusion of outperformance.

Trustees may think performance is "above benchmark," but it is really just Phantom Alpha. Many times, we have witnessed bottom-quartile performance being shown as "above benchmark."

#2- What is our Peer Group?

A custom-managed QDIA using mutual funds and CITs creates a performance measurement problem. What is the proper level of risk, volatility and maximum drawdown (VAR)? What returns are reasonable and over what period? What is the correct peer group to gain accurate and reliable perspective to judge returns?

If these questions are answered by the investment consultant or OCIO, they may be using custom peer groups designed to be a "slow rabbit" creating favorable rankings.

#3- Is There Alpha Net of Fees?

There are two sources of alpha in an internally managed QDIA pool. The first is the actively managed mutual funds. The second is the asset allocation, rebalancing, and mutual fund hiring and firing by the investment consultant or OCIO. 

Even though these funds rebate fees to pay for record keeping services, if they collectively deliver negative alpha greater than the rebates, the true cost to plan participants may be far greater than paying hard dollar fees for record keeper services.

Initiate an Affirmative Defense

Tibble v. Edison, Hughes v. Northwestern, and Cunningham v. Cornell all raised the bar for DC plans under ERISA. To improve your chances of successfully being granted a motion to dismiss, take proactive action today with a Peer Fee & Performance Review from OCIO Monitor.

Our independent and unconflicted analysis not only provides an affirmative defense, but our metrics often discover systematic and situational patterns to improve future returns.

OCIO Monitor is Your Solution

ERISA states that fees must be reasonable. The Department of Labor clarifies that fees must be reasonable “in light of the quality and quantity of services provided.”

OCIO Monitor objectively and quantitatively measures the investment value-add of a plan’s QDIA, net of all fees and rebates. This is the ultimate litmus test for either initiating or defending against a lawsuit by participants alleging excessive fees or poor performance.

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