Opinion

Felix Salmon

Obfuscation of the day, John Hancock edition

By Felix Salmon
April 4, 2011

Matt Yglesias wonders whether he should invest some of his 401(k) in John Hancock’s International Value Fund. Naturally, one of the key pieces of information about the fund that he wants to know is its expense ratio: what kind of fees does it charge?

Yglesias eventually found the relevant bit of the John Hancock website; it runs to 421 more or less incomprehensible words. (Exempli gratia: “For internally-managed Funds advised and sub-advised exclusively by John Hancock’s affiliates, the total fees John Hancock and its affiliates receive from these Funds may be higher than those advised or sub-advised exclusively by unaffiliated mutual fund companies. These fees can come from the Fund or trust’s Rule 12b-1, sub-transfer agency, management, AMC or other fees, and may vary from Fund to Fund.”)

The upshot of all the prose? If you want to find out the fund’s expense ratio, you have to phone up John Hancock and ask them to send you its most recent “Returns and Fees” document — which of course isn’t simply available online, and which is subject to change in unpredictable ways in future.

This kind of thing seems tailor-made for the Consumer Financial Protection Bureau to crack down on. Arthur Levitt, for one, would surely approve:

For years, I have pressed for “plain English” in financial documents that go to the investing public, but with only mixed success. The problem, it appears, is that such efforts get tugged into the ditch by the irresistible pull of legal jargon. The language of lawyers is not spoken by Aunt Edna, who rightly senses that if something sounds complicated, it is. The advice of Will Rogers comes to mind: “I love words but I don’t like strange ones. You don’t understand them, and they don’t understand you. Old words is like old friends—you know ‘em the minute you see ‘em.”

You wouldn’t buy an investment from a stranger, so why buy one wrapped in strange language?

It’s not just the mutual fund companies who deserve the blame here — it’s also the 401(k) administrators at places like Yglesias’s employer, who ignore the degree to which the options they’re choosing are readily comprehensible to their employees.

There are three main reasons why investments in 401(k) plans significantly underperform investments in defined-benefit plans. The first is that 401(k) investors have to rotate into relatively low-risk fixed-income instruments as retirement approaches and their risk appetite declines; defined-benefit plans never need to do that. The second is that defined-benefit plans have the ability to diversify into many more asset classes than 401(k) plans can. And the third is that there are multiple points at which 401(k) performance can be scuppered: at the fund-manager level, at the corporate-benefits level, and of course at the individual level. Bad choices at any one of those levels are enough to result in severe underperformance; and it’s entirely possible that you can have bad choices at all three points.

Will the CFPB have the power or the inclination to clean up the mess that is the 401(k) system? I doubt it. But if it doesn’t, no one will. And the likes of John Hancock will continue to obfuscate their customers for no good reason.

Update: Stephen Lubben points out that under Dodd-Frank, the CFPB has no oversight of investments: there’s no way they can be of use here.

Comments
14 comments so far | RSS Comments RSS

I agree that most documents filed with the SEC are egregiously incomprehensible to ordinary folks. Did you know that Registered Investment Advisers now MUST file their main registration form (ADV part 2) in plain English? I hope that all SEC documentation follows suit.

Here’s the SEC’s guide to Plain English, if you’re curious: http://www.sec.gov/pdf/handbook.pdf

Posted by jamesagain | Report as abusive
 

[I will take the liberty of cross-posting a comment I made at MY's blog:]

It bears considering whether the best place to look for the information that you want about this fund is the fund adviser’s web site. Regardless of how eager (or reluctant) the fund adviser may be to tell you the things you want to know, the fund adviser is going to concentrate on complying with SEC disclosure rules and providing preemptive disclosures to avoid lawsuits. You should probably look elsewhere for consumer advice.

In particular, if you run the fund ticker symbol for the John Hancock International Value Fund (JIVIX) through Google, it will show you the expense ratio immediately.

This state of affairs is not unique to mutual funds. Want to know if the Ford Focus is a good buy and a reliable car? Don’t go to the Ford website, which will mostly tell you about what colors and options are available (useful in its own way, but it won’t answer your questions). Go to edmunds.com or cars.com or somewhere like that.

Full disclosure: I work occasionally for mutual fund advisers and trustees.

[I would add in respect of this comment: "And the likes of John Hancock will continue to obfuscate their customers for no good reason." The fact is that there are all kinds of lawsuits about fee disclosure language in mutual fund prospectuses, and I would not want to be the John Hancock attorney who suggested omitting the sentences you suggest are examples of pointless obfuscation.]

Posted by alkali | Report as abusive
 

(1) It is true that individual investors tend to be more conservative than the pension funds, however this does not by itself explain the gap in performance.

(2) Asset diversification is a valuable tool — but it serves primarily to reduce risk, not boost returns.

(3) Anecdotal evidence suggests this is the key point. Small investors often panic when the market falls because they don’t understand the markets in which their money is playing. So when something frightening happens, they pull out (at the worst possible time). Pension funds tend to shrug that off — they may not take advantage of a drop by reallocating into the bargain-priced sector, but neither do they flee.

The key to investment success is understanding your investments. The flip side of that is to invest in what you understand. If you do not understand a certain type of security, then you are likely to buy or sell at the worst possible time (while those who DO understand the security will eat your cake).

Seems to me those pension fund managers who were investing in MBS might do well to heed this advice as well?

Mutual funds (i.e. “professional management”) are no substitute for knowing what you are doing. If you aggregate 100 different stocks that you don’t understand, you end up with a diversified mutual fund that you don’t understand. And you’ll still sell into the teeth of a market panic.

Posted by TFF | Report as abusive
 

I should add that understanding all 500 stocks in the S&P500 would be a Herculean task (and one that no professional analyst would attempt). If you invest in a stock index, you by definition do not understand your investment — and only have the vaguest idea whether it is safe, risky, overpriced, underpriced… Estimating its value in ten years is even trickier, so much so that people tend to fall back on models rather than attempting a bottom-up analysis.

Read Felix’ various comments on “the stock market” and you will see proof of my point. (Not his fault — nobody can hope to understand a system that large.) If I had so little understanding of my investments, I would be hunkered down under a table after the volatility of the last couple years!

Posted by TFF | Report as abusive
 

I agree with alkali that lawyers are probably at least partly involved in obfuscating official documents.

Let me push back a bit against a point from TFF that is often made by Felix about not understanding large aggregations; perhaps 3 or 4 years ago (and to a lesser extent today) people have used diversification as an excuse for not understanding investments well enough, but there is truth to both 1) you can never understand an investment perfectly, but there’s a lot of ground between there and understanding only that its ticker symbol is the same as the initials of your first crush, and 2) that understanding each $1B of possible fluctuation in future earnings of each of several companies is less valuable the more diversified you are. Unless correlations are literally 1, you gain something from diversification in terms of risk management, and the optimal granularity of information-seeking presumably drops.

Posted by dWj | Report as abusive
 

Wealthfront recently published with the help of Lipper Inc. (the leading mutual fund market research form), a detailed analysis of all the fees an investor pays in an average actively managed mutual fund. When you include all the components (including the hard to find ones) and use an arithmetic average (rather than an asset weighted average which makes the fees look a lot lower), the total average actively managed mutual fund fees is 3.01% of assets under management. Please see https://www.wealthfront.com/blog/activel y-managed-mutual-fund-expenses/ for details

Posted by AndyRachleff | Report as abusive
 

dWj, good point on diversification as risk-management, but you still need to know all the stocks in your portfolio well enough to know that they are sound companies. Diversifying into bad companies is always a bad idea.

Despite my polemy, we have roughly half our stock investments in a broadly diversified low-cost fund (that essentially acts as a composite domestic/international index). We might not have chosen that, but it is simply the way the system works. The rest of our stock investments are divided ~15 different ways, with no single security comprising more than 5% of total assets.

For me, working alone, that seems a reasonable balance between diversification and confusion. Had I a larger allocation to JNJ this year, I would have been sorely unhappy with the results!

Posted by TFF | Report as abusive
 

“Will the CFPB have the power or the inclination to clean up the mess that is the 401(k) system? I doubt it. But if it doesn’t, no one will.”

Any plan sponsor who dosen’t clearly disclose all fees paid by plan participants can expect to hear from the department of labor. I’m on the work group that manages our 401k and we get updates from our service providers all the time to make sure our disclosure is compliant with ERISA regs.

http://www.dol.gov/ebsa/publications/401 k_employee.html

Posted by y2kurtus | Report as abusive
 

I’m sorry, but Alkali’s comment is nonsense.

Lawyers undoubtedly had a lot to do with John Hancock’s windy evasiveness, but even if I’m willing to believe that all that boilerplate is needed to avoid litigation, I’m still left with the fact that John Hancock won’t give you the number. You’ve got to make a phone call.

And there’s a simple control to be made here: I checked out a Vanguard fund — Explorer Value Fund, a non-indexed small cap value fund. It took me all of 30 seconds to find that the expense ratio was 0.56%, and that the industry average for similar funds was 1.48%.

So, is Vanguard simply being reckless? Do they hold down costs by refusing to employ counsel? Is John Hancock’s ratio vastly more difficult to calculate?

Or is it possible that they’re being evasive simply because they don’t want you to know the number?

Posted by Thorvald | Report as abusive
 

y2kurtus, you’re missing the point. The plan sponsor can and does disclose all fees paid by the plan participants, but does so in a manner that is utterly opaque to even educated employees who are contributing their wages to the plan.

As such, the disclosure, while meeting the letter of the law/regulations, is useless to the end-user of the information, who wants to know what portion of their contributions, that is to say their hard-earned wages, is being siphoned off to support the bolivian marching powder habit of some Wall St. type.

Posted by Strych09 | Report as abusive
 

Yes, y2kurtus, you are way off base on this one…

Back in my ignorant youth, at my first job, I had a salesman try to sell me a 403b deferred compensation plan. Turned out it had annuity fees of 1.5% a year on top of management fees, for a total cost in the 2.5% to 3.0% range. Yet to figure this out, I had to piece together information from multiple paragraphs, spaced throughout a twelve-page agreement.

Had I signed on to that, and stayed in the plan (there were exit fees as well, though I couldn’t figure them out) I would have given away well over $100,000. Ouch!

Bury a disclosure in enough fine print and you effectively aren’t disclosing anything at all.

Posted by TFF | Report as abusive
 

Perhaps I am “way off base” because my bank is so far ahead of the curve that we are a golden role model for others to follow… but I doubt it.

Our ADP administered 401k plan website clearly discloses the exact expence ratio paid by participants for all of our options. I’m told that ADP is a top player in the 401k admin space and I’m sure everyone they serve has the same interface we do.

We have been advised by ADP and others that anything less than that full and straightforward disclosure is afoul of DOL guidelines. If you click on the link I included in my previous post and stroll around the DOL website you’ll find that clear and simple disclosure of fees born by participants is a big area of focus for the DOL.

Posted by y2kurtus | Report as abusive
 

Maybe I am 15 years out of date, y2kurtus? All I know is that I was given a hard sell by somebody invited into my school, encouraged to sign a sheaf of papers without having had the chance to read them, and the damning numbers were NOT prominently displayed in the documents.

If that is no longer the industry standard, then I apologize for the slander. Yet I continue to read articles of people preying on senior citizens — so I’m skeptical.

Posted by TFF | Report as abusive
 

A company which offeres a 401k plan to it’s employees owes those employees a fidicuary standard of care in the selection of investment options and the disclosure of the costs born by participants. This became a huge issue when the supreem court allowed participants to sue providers in class action law suits.

http://www.usatoday.com/money/perfi/reti rement/2008-02-20-401k-scotus_N.htm

The very shady industry standard TFF described is in my massively biased opnion still standard practice for annuity sales… here’s 20+ pages of fine print… sign here… yes I just made an 8% comission… BARF!

Like always there are probably some very honest and ethical agents out there… but in the world of annuities the ratio of bad apples to good apples has been unacceptablely high in my expeiernce.

Posted by y2kurtus | Report as abusive
 

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