Calif. change of funds trades lower costs for less information

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October 24, 2006|By Charles Jaffe | Charles Jaffe,Marketwatch

It was the kind of notice that millions of mutual fund investors get - and ignore - over the course of the year, a simple two-page message about a change of funds in the retirement plan.

Like most notices that retirement funds are being changed, it was probably greeted with a shrug of the shoulders and a sigh of resignation.

But investors in retirement plans across the country can learn something from the subtle changes that went into effect in early October in the Savings Plus Program for California state employees. Changes in the plan created an ideal template for investors trying to size up changes being made in their retirement plans.

California's Department of Personnel Administration told affected shareholders last month that five funds in the plan were being replaced, with the money moving into separate accounts or to a lower-cost share class of their existing funds. The move was made because the state had negotiated fee reductions, and cutting costs is a good way to improve long-term rates of return.

The notice included a chart, showing the old fund, the new fund and estimating the savings.

On the surface, it was a no-brainer, as the one thing every fund investor wants is lower costs.

But there are issues below the surface, the kind of stuff that the plan sponsors often fail to explain.

For starters, consider the one fund that was changing share classes: Investors in the Growth Fund of America (AGTHX) were being moved into the fund's "R-5" share class. Most investors are a generally unclear about R shares - typically available only in retirement plans - if only because cost structures can vary widely. As the name implies, the R-5 shares are one of five categories of R shares for Growth Fund of America, and costs run from 1.44 percent for the R-1 class to the 0.38 percent of the R-5.

In all of those classes, the shareholder has the benefit of easily tracking the new fund because it has a ticker symbol.

That's not the case with the four other funds being changed in the California plan, where the money was moved to "separate accounts." Retirement plan separate accounts pool the assets of workers and turn them over to a money manager, who typically runs the money at a lower cost than with a traditional fund.

The trade-off for the savings is the loss of transparency.

So, when California state employees were told that their money was moving from T. Rowe Price Mid Cap Growth (RPMGX) to the Savings Plus Plan Mid Cap Managed Fund-Growth, they couldn't know what to think or expect. With no ticker symbol, investors can't track the fund in their newspaper or on their preferred Web site (unless that site is run by the Savings Plus Plan). They weren't told whether the new accounts have the same managers (in the California case, they do), and they couldn't be certain the separate account would be run parallel to the existing fund.

Those are the issues an investor needs to sort through before tossing the paperwork and just accepting the changes. In many cases, the results will not be as good as those the California workers got.

"A lot of employers are shifting the costs of the plan to the workers, so it's not uncommon to see costs going up," says Tom Scalici, managing director for Cornerstone Advisors Asset Management Inc., of Bethlehem, Pa., a company that builds and oversees retirement plans for companies.

"First, employees should make sure that costs really are going down. ... With separate accounts, workers save on lower expenses, but they give up getting regular information on what's in the fund and they can't download and track it on Microsoft Money or Quicken. That's an issue for some people."

If the separate account has the same manager trying to run money the same way the original fund did, employees might be able to use the old fund in their portfolio-tracking tools to get a reasonably close approximation of results.

But workers must also monitor separate accounts closely over time, as plan sponsors can swap out managers of separate accounts quickly, easily and without warning.

If California were to change managers on its Mid Cap Managed Fund-Growth, it would not have to send out a notification similar to the one about changing funds. Investors would still be in the same separate account, but it would be run by a different managers.

"Not every change in a retirement plan is good for the employees," says Russel Kinnel, director of mutual fund research at Morningstar. "It can be a tough call; some people would say any cut in expenses is a good one, but others will say that giving up important information about the fund is a big cost if all you are saving is a few pennies."

Charles Jaffe writes for MarketWatch. He can be reached by mail at Box 70, Cohasset, MA 02025-0070.

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