A recent study by the Investment Research Team at Retirement Plan Advisory Group found that there is a “skill” premium among the highest quality investment managers. Simply put, high quality managers typically have a higher average expenses than the average investment option.
While these low cost investment options presumably have an advantage in outperforming their higher cost counterparts, the study supports the conclusion that simply choosing an actively managed option based on cost is a losing proposition.
Simply having the lowest cost option is no panacea for a comprehensive investment due diligence process. While the study did not address the specific reasons for the so-called “skill” premium, some reasons may include:
- higher than average compensation (for the portfolio manager),
- a larger and/or more experienced team of research analysts,
- and/or a greater investment in systems and technology to help implement and manage the strategy.
Evidence supports that, as with returns, looking at expenses alone is flawed since it leaves out other significant and possibly even more material criteria about the investment manager.
Fiduciaries increasingly need to balance the responsibility of offering appropriate plan investments and services that help participants build adequate retirement income security, while negotiating and maintaining the lowest possible plan fees. While plan fiduciaries are responsible for “defraying reasonable expenses” under ERISA, a fiduciary is not required to offer a plan with the lowest expenses.
The “skill” premium suggested above is one indication that cost alone may lead to the wrong conclusions, or, as the study showed, inferior investment options.