Excess revenue is about fairness. How much profit is enough? And whose money is it anyway?
You might not know what revenue sharing is because it is one of the best kept secrets in the DC/401(k) marketplace. In part, this is because the recordkeepers themselves don’t really want you to know about it and also because at first glance, it may seem confusing. In addition, many plan sponsors don’t understand why revenue sharing is relevant to them because they themselves don’t pay recordkeeper fees.
Plan sponsors who take the time to understand the concept of revenue sharing, will find that it is well worth the effort for it is the key to understanding the economics of the retirement plan industry and a crucial tool for driving down plan costs and helping plan participants to keep more of their retirement savings working for them.
What is revenue sharing?
Revenue sharing is a common industry practice in which all or most of the recordkeeper’s costs to provide its services are offset by the plan investments. Rather than charge a plan sponsor a hard-dollar fee for its services, the recordkeeper’s costs are offset by some combination of asset-based investment management, 12b-1 or sub-transfer agent fees. In this nearly universal pricing model, plan participants are, in effect, subsidizing the recordkeeper’s costs because they pay the plan investment fees.
When revenue sharing is being used to defray reasonable costs associated with the recordkeeping and administration of the plan, it makes retirement plans affordable for virtually all types of organizations. However, it can become costly when plan sponsors don’t understand how it works and by default, allow the recordkeeper to collect an asset-based revenue stream. To the extent that revenue sharing is high, it becomes a drag on investment performance. At Blue Prairie Group, we monitor revenue sharing fees to keep them in check. Again, it’s important to remind ourselves that participants are paying the cost.
The mechanics of revenue sharing
A large percentage of mutual funds used in the DC/401k marketplace are structured to share a portion of their fees to offset recordkeeping costs. This revenue usually comes in the form of 12b-1 fees which usually range between 25 to 100 basis points and sub-transfer agent fees which are generally smaller, and can take the form of asset-based or per participant fees. For many fund families, it makes economic sense for them to give up a small piece of their revenue stream in order to get on as many platforms as possible as a way to increase their distribution potential.
What are the true costs of a mutual fund?
The total cost of the fund is comprised of three separate pieces: the investment management fee, the 12b-1 fee and an “other” fee . Each source contributes a small piece towards the revenue sharing arrangement with the recordkeeper .
What are 12b-1 fees and sub-transfer agency fees?
A portion of a fund’s total expense ratio that is often used to offset recordkeeping expenses 12b-1 fees are used by funds to pay for marketing and distribution costs, including recordkeeping fees, and usually range between .25 to 1 percent. Sub-transfer agency fees are used to pay for account management services. These fees vary based on the contractual relationship between the fund and the recordkeeper.