401(k) providers should probably hit the “open architecture” concept a little harder.
Invoking past (current?) controversies over whether or not wirehouse advisors were pressured to sell proprietary products, a soon-to-be published study in the Journal of Finance finds that 401(k) plan providers that also offer mutual funds include said funds in plans they administer for no other reason than they can. The benefit, of course, is the fees and resulting revenue they’re able to keep in house.
The paper, entitled “Are 401(k) Investment Menus Set Solely for Plan Participants?” finds the following:
- Mutual fund companies that are trustees of 401(k) plans must serve plan participants’ needs, but they also have an incentive to promote their own funds.
- The analysis suggests that these trustees tend to favor their own funds, especially their poor-quality funds.
- And 401(k) participants do not offset this bias by shifting their savings away from trustee-affiliated funds.
- In short, fund companies serving as trustees often make decisions that appear to adversely affect employees’ retirement security.
“On the one hand, fund companies are hired by plan sponsors–and required by law–to create menus that serve the interests of plan participants,” the authors note. “On the other hand, they also have an incentive to include their own proprietary funds on the menu, even when more suitable options are available from other fund families.”
The differences in behavior with their own funds as opposed to others is staggering, especially when ridding an investment menu of poor performers. The authors report that mutual funds ranked in the lowest decile based on their prior three-year performance have a deletion rate of 25.5% per year if they are unaffiliated with the plan’s trustee and a deletion rate of just 13.7% if they are affiliated with the trustee.
“Those involved in managing 401(k) plans are expected to make decisions for the exclusive benefit of plan participants and beneficiaries,” the authors write. “This study provides evidence that mutual fund companies involved in plan management often act in ways that appear to advance their interests at the expense of plan participants.”
Where mutual fund companies serve as plan trustees–indicating their involvement in the management of the plan–additions and deletions from the menu of investment options often favor the company’s family of funds, they add. More significantly, the bias is especially pronounced in favor of affiliated funds that delivered sub-par returns over the preceding three years.
Participants do not shift their savings to undo this favoritism, especially the favoritism shown to sub-par affiliated funds,” the authors’ conclude. “The study also found that the lackluster performance of these sub-par funds usually persists. These findings thus suggest that, with respect to setting 401(k) menus, mutual fund companies tend to influence decisions in ways that appear to adversely affect employee retirement income security.”
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.