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Wisconsin Education Association Council

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Guest Skeptical

All:

 

Waiting for a reply from WEAC but in the meantime I thought I would address the main premise of this thread.

 

Is this a potential national model and how could it be improved?

 

Here are a few things to consider:

 

There is really no documentation available to new enrollees to support the claim of low administrative expenses. The WEA benefits web site does not provide an annual report for the WEA Tax-sheltered Annuity Trust, and apparently no form 5500 or 990 is required to be filed. Perhaps this information is available via the "members only" link but why not put it with the brochures and prospectus on the main site. Do the admin charges show up as a line item expense on participants statements? Perhaps, but unlikely. There is no sample "how to read your statement" on the web site either.

 

Asset-based pricing for admin doesn't make sense to me. The cost of administration is driven by the number of participants, not asset size. A 10,000 participant plan requires more resources to run than a 1,000 participant plan. So if the admin fee is capped at $225 then the average cost for everyone is something less than $225. I would prefer a flat fee regardless of account value. Large accounts would no longer subsidize small ones.

 

The WEA has two other corporate entitites, WEA Financial Advisors, Inc. and WEA Investment Services, Inc.. These two units actively market IRAs and insurance to 403(b) participants. The profit from the sale of these supplemental products is likely substantial. As a participant I would be wondering if my admin fee, that pays for on site counselors, is supporting a sales operation for the WEA. In other words, what if the plan rep spends the next two weeks meeting with my colleagues about their IRAs? This has nothing to do with the 403(b). Is my admin fee HIGHER than needed to support this unrelated (to the plan and me) outside sale, or is the admin fee LOWER because of an indirect subsidy, the profit on the sale of IRAs (funds really) and insurance?

 

If the lower fees can ony be accomplished by generating additional revenue through the sale of supplemental products then this could be a barrier to national adoption.

 

Essentially I'm for 100% disclosure of expenses. Any dollars deducted from a participant's account should ALWAYS be shown as a line item on the account statement.

 

Cheers,

 

Jim

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Guest Sierra

Hi Jim:

 

I want to learn how to determine how close the published expense ratio is to 100.0 percent of all costs incurred in fund/portfolio operation. For example: In the NJ Plan, as a footnote, they disclose that the expense ratio includes all administrative/recordkeeping fees. How do I know for sure that, for example, trading commissions are included?

 

Thanks,

Joel

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Guest Skeptical

Hi Jim:

 

I want to learn how to determine how close the published expense ratio is to 100.0 percent of all costs incurred in fund/portfolio operation. For example: In the NJ Plan, as a footnote, they disclose that the expense ratio includes all administrative/recordkeeping fees. How do I know for sure that, for example, trading commissions are included?

 

Thanks,

Joel

 

Joel,

 

Well the trading (transaction) costs are NEVER included on the financial statements reported by an investment company in their annual report. It's not required to be. So the term "total expenses" or "total expense ratio" is to be nice, just a myth. The actual expenses are ALWAYS HIGHER than the reported expense ratio.

 

Now are the NJ admin/ recordkeeping fees included? The Prudential disclosure says so, but that would be tough to verify. They have a complex structure. Some investment choices are retail funds wrapped in an annuity and presented as a separate account, some are separate accounts run / advised by Prudential, some are sub-advised separate accounts, a few are actual retail funds. Tricky, Tricky!

 

There are many, many, many opportunities for Prudential to make money on this thing. The HUGE CONFLICT is that their compensation varies with each investment choice. It would VERY interesting to see how participants have spread their assets among those choices, when guided by Prudential "consultants".

 

I use to do an expense ratio validity calculation. Example: Funds reports 1.0% expense ratio (.65% Mgmt fee, .25% 12(b)-1, .10% Other) but also reports $7.35 million in brokerage commissions in their SAI:

 

To find this look for the Statement of Additional Information (SAI) for the particular investment company, available at the SEC EDGAR site or sometimes on the vendors web site. Search through that massive document for "brokerage" or "brokerage commissions" using the "find (on this page)" feature of your browser or reader. Keep in mind that while many funds report these costs separately in the SAI there is no requirement, so you will often find nothing.

 

That happens to be .85% of average asset value, so adding that back to the REPORTED number of 1% we get an ACTUAL expense ratio of 1.85%. The validity calculation is actual / reported so in this case 185%. Think that's bad. You'll find it all the time in small cap funds with heavy turnover. That's because part of that .85% is REBATED back to the investment adviser.

 

Is there a particular fund you were trying to verify or the NJ plan in general?

 

Hope that helps,

 

Jim

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I beleive that some of the fund families (Fidleity comes to mind) make it somewhat easier for you by actually providing the brokerage commission in the SAI as a percentage of the average fund assets for the year, so the percentage can easily added to the expense ratio.

 

Also, do index funds generally incur less brokerage commissions than actively managed funds, since there would ostensibly be fewer trades and hence less commissions?

 

Finally, since brokerage commissions are not included in a fund's expense ratio, are the also not accounted for in the returns net of expenses disclosed by fund families (in other words, do I need to deduct the brokerage commission from the "net" return in order to derive the actual return of a mutual fund)?

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Guest Sierra

 

Hi Jim:

 

I want to learn how to determine how close the published expense ratio is to 100.0 percent of all costs incurred in fund/portfolio operation. For example: In the NJ Plan, as a footnote, they disclose that the expense ratio includes all administrative/recordkeeping fees. How do I know for sure that, for example, trading commissions are included?

 

Thanks,

Joel

 

Joel,

 

Well the trading (transaction) costs are NEVER included on the financial statements reported by an investment company in their annual report. It's not required to be. So the term "total expenses" or "total expense ratio" is to be nice, just a myth. The actual expenses are ALWAYS HIGHER than the reported expense ratio.

 

Now are the NJ admin/ recordkeeping fees included? The Prudential disclosure says so, but that would be tough to verify. They have a complex structure. Some investment choices are retail funds wrapped in an annuity and presented as a separate account, some are separate accounts run / advised by Prudential, some are sub-advised separate accounts, a few are actual retail funds. Tricky, Tricky!

 

There are many, many, many opportunities for Prudential to make money on this thing. The HUGE CONFLICT is that their compensation varies with each investment choice. It would VERY interesting to see how participants have spread their assets among those choices, when guided by Prudential "consultants".

 

I use to do an expense ratio validity calculation. Example: Funds reports 1.0% expense ratio (.65% Mgmt fee, .25% 12(b)-1, .10% Other) but also reports $7.35 million in brokerage commissions in their SAI:

 

To find this look for the Statement of Additional Information (SAI) for the particular investment company, available at the SEC EDGAR site or sometimes on the vendors web site. Search through that massive document for "brokerage" or "brokerage commissions" using the "find (on this page)" feature of your browser or reader. Keep in mind that while many funds report these costs separately in the SAI there is no requirement, so you will often find nothing.

 

That happens to be .85% of average asset value, so adding that back to the REPORTED number of 1% we get an ACTUAL expense ratio of 1.85%. The validity calculation is actual / reported so in this case 185%. Think that's bad. You'll find it all the time in small cap funds with heavy turnover. That's because part of that .85% is REBATED back to the investment adviser.

 

Is there a particular fund you were trying to verify or the NJ plan in general?

 

Hope that helps,

 

Jim

 

 

Jim:

 

As you say the additional costs may not be found in the SAI so can you suggest a formula for extimating the TRUE expense ratio of funds in general? In other words if you did not do the research above how close to the TRUE expense ratio would your estimate have been?

 

Peace and Hope,

Joel

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Guest Skeptical

Joel,

 

There is a rule of thumb for estimating the cost, but I prefer to look for the hard data found in the SAI. I just will not invest in a fund or family that hides or makes this data difficult to find. Of course you can always call the fund as well, but I presume that they only hide info UNFAVORABLE to the fund. The funds with minimal transaction costs report it readily.

 

The rule of thumb cited by Bogle from Vanguard is:

 

Transaction costs = ((Portfolio Turnover TIMES 200%)*.6)

 

So a fund with 85% turnover would have additional transaction costs of 1.02%. This is a wildly, somewhat inaccurate ESTIMATE, but the correlation between portfolio turnover and transaction cost is intuitive.

 

I think the following study is helpful:

 

Mutual Funds Brokerage Commissions White Paper

 

They provide an estimate by asset class and style, Mid Cap Value, Small cap Growth, etc.

 

Benefitsgeek:

 

You are right, some funds like Fidelity publish the data up front.

 

You said:"Also, do index funds generally incur less brokerage commissions than actively managed funds, since there would ostensibly be fewer trades and hence less commissions?

 

Finally, since brokerage commissions are not included in a fund's expense ratio, are the also not accounted for in the returns net of expenses disclosed by fund families (in other words, do I need to deduct the brokerage commission from the "net" return in order to derive the actual return of a mutual fund)?

 

You are correct about index funds. The lower the turnover, the fewer trades executed, the fewer commissions paid.

 

It is important to understand that the Investment Adviser to the fund uses excess brokerage commissions (legal under section 28(e) and paid from fund assets), to pay for "research AND services". What classifies as a service? Just about anything. So that extra 50 bps in brokerage commissions is actually 20 bps for trading and 30 bps to pay for the operating expenses of the Investment Adviser.

 

The net return reported by the fund DOES include this expense, there is no need to deduct it.

 

Cheers,

 

Jim

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Guest Skeptical

No response from the WEAC, regarding my request on October 3rd, for information about revenue sharing.

 

Best regards,

 

Jim

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