A recent academic study examined whether mutual fund companies that act as trustees for 401(k) plans “display favoritism towards their own funds.” Although its conclusions will not shock many advisers, the research can be useful as a source of independent evidence on this important issue, and reinforce the vital role that an independent adviser can play in overseeing plan investments.

The study, titled “It Pays to Set the Menu: Mutual Fund Investment Options in 401(k) Plans,” offers the following conclusions:

  • Poorly performing funds “are less likely to be removed and more likely to be added to a 401(k) menu if they are affiliated with the plan trustee,”
  • There is no evidence that plan participants “undo their affiliation bias through their investment choices,” and
  • The subsequent performance of poorly performing affiliated funds “indicates that these trustee decisions are not information-driven and are costly to retirement savers.”

The average performance deficiency for proprietary funds that underperformed benchmarks averaged 3.6% on a risk-adjusted basis, according to the study.
Strong Trustee Preference

In sum, “We find that despite their fiduciary responsibilities, trustees have a strong preference for their own funds,” stated the study’s authors (Veronika Pool and Irina Stefansu of Indiana University and Clemens Sialm of the University of Texas).

Most of the plans studied were open-architecture, so plan sponsors in theory making changes in the fund line-up should not have been a big challenge. The study noted that when poorly performing funds of one fund organization were on the investment menus of plans trusteed by other organizations, those other plans were much quicker to drop them, than the plans trusteed by the fund provider.

“I think the study is correct,” says Tom Ming, CEO of Tower Rock Advisors in Bakersfield, Calif. “This wouldn’t be happening” as much if more plans “had an fiduciary adviser looking out for them.”

It must be noted that the most recent plan data used in the study was from 2009. Harris Nydick, a founding partner of CFS Investment Advisory Services in Totowa, N.J., says while he has seen some progress since then in the part of mutual fund companies, the fundamental problem remains.

Harris was recently turned down by a mutual fund organization seeking the services of an independent fiduciary to oversee the company’s 401(k) plan investments for its own employees. That happened when he made it clear he would not hesitate to recommend that the company drop any of its own funds from the investment menu if he believed they were not suitable.

He recently requested on behalf a client that the mutual fund trustee servicing that account make specific external funds to available to the plan. “They said they can do it, but it will cost.”

And while higher cost is one variable in the fund selection process, “it’s not the only factor,” Harris says, a basic point that he sometimes needs to remind clients. “The problem is when you don’t see value for what you’re paying.”

Register or login for access to this item and much more

All Employee Benefit Adviser content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access