Are Passive Indices Immune from Fiduciary Rules? By: Gabriel PotterMBA, AIFA® 2016.08.09

As we have noted in our monthly articles (Trends in Portfolio Construction) and blog posts (Lower Due Diligence for Passive Investments), the retirement industry is adopting a much higher amount of passive, index investment.  This is true for both individuals sensitive to the fees they’re paying and institutions wary of the due diligence burden on imperfectly transparent actively managed products.  You might be forgiven for thinking that the greater legislative scrutiny on fees that index funds are now getting a free-pass in terms of the new fiduciary rules impacting retirement plans. However, that would be a mistake. 

Moreover, you might think that financial industry companies would be the most aware of their fiduciary duties and most proactive towards meeting their obligations.  We’ve seen how that assumption has been wrong in the past, given the lawsuits against companies like Fidelity, American Century, Allianz, Franklin Templeton, Neuberger Berman, and so on.  Another case in point:  Just this week, New York Life Insurance is the latest company fired for breach of fiduciary duty.  What makes this case unique is New York Life is being sued exclusively because of the index funds they use in their retirement plan lineup for employees.  Specifically, New York Life used Mainstay’s S&P 500 Index fund as a centerpiece in its lineup.  Mainstay’s S&P 500 tracker is not the least expensive index fund, and Mainstay is also a wholly owned subsidiary of New York Life; this conflict of interest prompted the lawsuit.

So no, using passive indices doesn’t give you a free pass. If anything, when you use an index fund, you have limited your criteria for selection and there are a smaller number of features to consider, meaning that investment committees must be even more vigilant.  If anything, you’ve got to be more aggressive with keeping your plan lean if you’re using indices since you’ve essentially established the primary criteria for meeting your obligation as minimizing cost.      





Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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