Private-Label Funds Gaining Popularity

By PAUL J. LIM

April 6, 1999 12 AM PT

TIMES STAFF WRITER

A small but growing number of investors won’t find their 401(k) retirement investments listed in any mutual fund charts or tables.

That’s because a small but growing number of investors aren’t investing their 401(k) assets in retail mutual funds at all.

Whether you realize it or not, some of your retirement money may be going into so-called separate accounts or commingled pools.

Commingled what?

Separate accounts are essentially private-label funds that a rising number of large 401(k) plan sponsors are paying mutual fund companies, insurers, banks and other money managers to create. In some cases, they’re even self-managed.

Commingled pools are variations of separate accounts, in which several employers may pool their assets in a private-label fund.

These special accounts come in a variety of packages. Some are modeled on an existing “off-the-shelf” retail mutual fund, essentially duplicating that portfolio.

Others are modeled on an existing retail fund, but with one or two wrinkles. For instance, a 401(k) plan sponsor may ask the managers of a popular growth stock fund to remain 100% invested in stocks in the separate account, even though the managers may have the flexibility to build a large cash position in their retail fund.

Still others aren’t modeled on existing funds at all. Rather, a plan sponsor may ask a money manager to create a new fund that invests in a specific type of asset--such as small growth stocks or emerging-market stocks.

Like a regular mutual fund, separate and commingled accounts invest in a diversified group of stocks and/or bonds.

But unlike a retail fund, you can’t track the performance of these funds through a daily newspaper or even a fund-tracking service such as Morningstar.

That can make it tough for employees to compare separate or commingled accounts with investments outside their 401(k). So the ability to make judgments about a portfolio can be impaired.

But the benefit is potentially higher returns in the long run.

Dozens of Southern California’s largest employers offer these accounts in their 401(k) plans. Nationally, about 10%-20% of various investment options offered in most 401(k)s come in the form of these special accounts, according to a recently released survey by Buck Consultants, a New York benefits consulting firm.

Many companies, such as El Segundo-based Hughes Electronics, a division of General Motors, and Woodland Hills-based Litton Industries, offer both retail funds and special accounts in their 401(k)s, while others offer only special accounts.

“There’s currently a lot of interest in these investments among big companies,” said David Wray, president of Profit Sharing/401(k) Council of America in Chicago.

Why are an increasing number of large employers going to the trouble of ordering private-label funds when there are more than 10,000 retail mutual funds to choose from--and when employees generally prefer to have recognizable name-brand funds in their plans?

One big reason: The accounts charge lower management fees.

The average expense ratio for a retail fund is about 1.5%. This means that for every $100,000 you have in your plan, the fund management company takes away $1,500 every year in fees.

Special accounts, by contrast, trim “about 25 to 40 basis points [0.25 to 0.40 percentage point] off what a similar retail fund would charge,” said Jim Rhodes, a regional manager for ManuLife Financial in Glendale.

“Most of the time, [employers] are buying a fund manager’s retail performance, and asking them to replicate that in a separate account for a lower fee,” Rhodes said.

These accounts can charge lower fees because they’re not subject to the normal costs and registration requirements of a mutual fund, said Ted Benna, head of the 401(k) Assn., a consumer group based in Cross Fork, Pa.

An account charging 1.1% in annual fees instead of 1.5% would save $400 a year per $100,000 invested. That may not sound like a lot of money, but as 401(k) balances grow over 20, 30, and even 40 years, it adds up.

Why would your company care about the fees, if it isn’t paying them?

Wray of the Profit Sharing Council answers that question with a question: “Who has the largest account balance in a company’s 401(k) plan?” Most likely, senior management.

“These are the people who have the most to gain with lower expenses because they have the most money in the plans,” Wray said. “And they tend to be more sophisticated when it comes to investing.”

And, more than anyone else in the company, they have the power to influence what your company’s 401(k) plan looks like.

Experts say the low fees alone can make separate or commingled accounts wise choices in a 401(k)--even though you may give up the ability to track the funds daily.

The special accounts have other advantages besides low fees. Because plan sponsors can order specific types of funds--or put in specific requests about investment style--a separate account may stay truer to its investing style than a corresponding retail fund.

“With an off-the-shelf fund, the plan sponsor has zero control of keeping the manager accountable,” Benna said. “But one of the advantages of [special accounts] is that there’s potential for tighter control.”

Indeed, if a plan sponsor wants to offer participants a pure small-stock fund, it can specifically demand this in a separate account.

But if tracking special accounts is more difficult for plan participants, what’s the best way to get the information you want? Ask your employee benefits department these questions:

* Does the account mirror an existing retail fund that you can regularly monitor? Are there any special distinctions between the account and the fund it’s modeled after?

* If the account doesn’t have a retail peer, will your plan sponsor provide you with quarterly performance reports and information on the account’s holdings?

Commingled pools aren’t required to provide investors with the same level of disclosure as retail funds. But most plan sponsors will provide a basic level of information--such as what the fund’s top 10 holdings are and what industries it invests in--to avoid legal liabilities for losses.

Luke Collins, director of KPMG’s personal financial counseling services in Chicago, said that a growing number of plans that offer commingled pools provide daily share pricing by phone or over the Internet.

* How much historical information is available on the account’s performance? Does it have at least a three-year track record--or does such a track record exist for the retail fund the account mirrors?

Ask if your 401(k) statements will show account performance relative to the performance of similar-style funds.

You also can compare an account’s performance to the average performance of comparable funds (such as “large growth” or “small growth”) in this section, which The Times repeats quarterly.

* What level of fees does the account charge? Make sure that the management fees are indeed lower than on a comparable retail fund. (Average retail fund fees are listed in a table on S9.)

Bill McNabb, head of Vanguard Group’s institutional services, argues that you shouldn’t pay more than 1% in management fees for a retail fund in a 401(k). If that’s the case, a separate or commingled account should charge no more than 0.75%--preferably less.

And if it’s a commingled pool that passively tracks an index such as the Standard & Poor’s 500, you should be paying far less.

In fact, Eastman Kodak offers an S&P; 500 index-modeled fund that charges 0.02% in annual expenses. By contrast, the well-regarded Vanguard Index 500 fund charges 0.18%--and it’s considered cheap.

Times staff writer Paul J. Lim can be reached at paul.lim@latimes.com.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Using Private-Label Funds in 401(k)s

Employers are increasingly using private-label funds, such as commingled pools and separate accounts, in 401(k)s, instead of “off the shelf” retail mutual funds. The chart below shows how prevalent these types of accounts are, based on asset types, according to a just-completed survey by Buck Consultants. Companies are more likely to use retail funds in riskier, actively managed investments.

STOCK FUNDS

Of those 401(k) plans that offer an index stock fund option...

* 82% offer it in the form of a mutual fund.

* 18% offer it in the form of a commingled pool, separate account or other.

Of those plans that offer a growth stock fund...

* 87% offer it in the form of a mutual fund.

* 13% offer it in the form of a commingled pool, separate account or other.

Of those plans that offer a small-company stock fund...

* 88% offer it in the form of a mutual fund.

* 12% offer it in the form of a commingled pool, separate account or other.

Of those plans that offer an international stock fund...

* 90% offer it in the form a mutual fund.