Gee …who would have thought? A new paper from the Pension Research Council investigates whether mutual fund families acting as service providers in 401(k) plans display favoritism toward their own affiliated funds.
Surprisingly (or not), the council finds that they do.
“Using a hand-collected dataset on retirement investment options, we show that affiliated mutual funds are less likely to be removed from and more likely to be added to a 401(k) menu,” the paper notes. “In addition, fund deletions and additions are less sensitive to prior performance for affiliated than for unaffiliated funds. We find no evidence that plan participants undo this affiliation bias through their investment choices. Finally, the subsequent performance of poorly-performing affiliated funds indicates that this favoritism is not information driven.”
Fund families involved in the plan’s design often face conflicting incentives, it argues. While they have an incentive to include their own proprietary funds on the menu, even when more suitable options are available from other fund families, they are also pressured by plan sponsors to create menus that serve the interests of plan participants.
“Surprisingly, little is known about whether and how these conflicting incentives influence 401(k) menus. This is concerning given that DC accounts are the main source of retirement income for many of the beneficiaries.”
The biggest relative difference between how affiliated and unaffiliated funds are treated on the menu occurs for the worst performing funds, which have been shown to exhibit significant performance persistence.
“For example, 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. On the other hand, funds in the top performance decile have a deletion rate of around 15% for both affiliated and unaffiliated trustees. Protecting poorly-performing funds by keeping them on the menu helps mutual fund families to dampen the outflow of capital triggered by poor performance and, as a result, mitigates fund distress.”
The authors conclude by noting their “evidence on favoritism is consistent with adverse incentives, and fund families may also have superior information about their own proprietary funds. Therefore, it is possible that they show a strong preference for these funds not because they are necessarily biased toward them, but rather, due to favorable information they possess about these funds.”
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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.
