Earlier this month, Fidelity Investments launched two new zero-fee index funds for retail investors, while simultaneously eliminating separate share classes in its existing index funds, a move that Fidelity claims will decrease fees overall. These developments mark a noteworthy milestone in what has been a fierce and long‑standing competition between large index fund providers such as Vanguard, Charles Schwab, and Blackrock. These announcements have many employees asking themselves, “Should my retirement plan be offering these “free” Fidelity funds?” Further, risk-aware fiduciaries may be wondering, “Am I at risk for fiduciary liability if our retirement plan committee decides not to utilize these Fidelity funds?” The answer to these questions—like many questions in the retirement plan arena—is “It depends!” While it is true that price is relevant when selecting and monitoring plan investments, it should by no means be the only consideration. In reviewing these Fidelity funds, fiduciaries should employ a review process that takes into account all relevant considerations, allowing them to make decisions that are in the best interests of their particular plan.
Zero Fee Retail Index Funds
The Fidelity Zero Total Market Index Fund and the Fidelity Zero International Stock Index Fund have been available to retail investors since August 3, 2018. In addition to offering an expense ratio of zero, these funds have no minimum investment requirement; in fact, a Fidelity spokeswoman confirmed that an individual could begin investing with just $1. Fidelity also announced that it will be indexing the funds in-house, which means relative performance will generally have to be evaluated by using custom benchmarks and not by using an established underlying index like the S&P 500. Although Fidelity has not yet confirmed specifics, Fidelity is likely able to offer these zero-fee funds in part due to savings from indexing in-house and through revenue from its securities lending practices (a common practice for index fund providers).
These funds are only available to individual investors who open a Fidelity account and are currently not available under defined contribution plans. It is possible, however, that these funds will act as a catalyst, prompting other large index fund providers to offer zero-fee index funds as an investment option within defined contribution plans.
Decreased Fees in Existing Funds
Perhaps more significant was Fidelity’s announcement to collapse all share classes into one class for its stock and bond indexed mutual funds, effective August 1, 2018. This means that all investors will be charged the same fees; retail investors will be charged the same as institutional investors, and small institutional investors will be charged the same as large institutional investors. According to Fidelity, “The average asset-weighted annual expense across Fidelity’s stock and bond index fund lineups will decrease by 35%, with funds as low as .015%.” Fidelity also eliminated minimum investments for all existing stock and bond indexed funds. These announcements should be met with a thoughtful approach by plan fiduciaries to evaluate whether Fidelity’s index funds are right for their respective retirement plans.
Selecting and Monitoring Investments
Retirement plan fiduciaries have the legal duty to prudently make decisions when selecting and monitoring a plan’s investment menu. The United States Department of Labor (the “DOL”) has stated that fees and expenses are not the only criteria that should be used when evaluating whether an investment option is right for a particular plan. Rather, the DOL has also noted the following as important factors for fiduciaries to consider:
Investment Performance – How does the investment’s overall investment gains (or losses) compare to applicable benchmarks in the short and long term?
Participant Population – How well do the investment’s characteristics align with the demographic of the population in the retirement plan?
Investment Strategy – What is the investment’s stated strategy, and what benchmark does the investment use to gauge the success of that strategy? How well does the investment’s management team execute on the investment’s stated strategy?
Diversification – Would the style of the investment be a good fit, taking into account the other investment options currently available under the plan? In other words, would the investment offer participants the opportunity to better diversify their investments in the plan?
In the context of evaluating index funds, plan fiduciaries should also take into account the competitive nature of the industry. Announcements regarding lower fees should be viewed within the broader context: index fund providers have been engaged in a decades-long race to the bottom. Taking this historical context into account, plan fiduciaries should understand that these recent announcements by Fidelity are part of a larger trend that will likely not stop here.
Retirement plan fiduciaries should resist the urge to hurriedly invest in the cheapest index fund available and should employ a thorough and thoughtful investment review process that takes into account relevant DOL guidance. Fiduciaries should follow the procedural guidelines for reviewing plan investments set forth in their plan’s investment policy statement. When making decisions regarding a plan’s index fund investment options, fiduciaries should understand the broader historical context of recent developments and consider how competitors might react to these developments in the short and long term.
If you have any questions regarding your plan’s index fund investment options, or about Fidelity’s recent announcements, please contact a member of our Employee Benefits Practice Group listed in the right-hand column of this page.