Defined contribution plan sponsors and their participants
need enhanced transparency and education regarding the plan's relationship with
their mutual fund company service providers, a finance professor said,
discussing an academic research study he co-authored. Clemens Sialm,
a finance professor at the McCombs School of Business at the University of
Texas at Austin, said the research shows that the number of and manner in which
proprietary mutual funds—which are funds affiliated with the service
providers—are added to and deleted from plan investment menus shows that there
is a bias in 401(k) plans in favor of proprietary funds.
According to the study, proprietary funds, with a 13.7
percent deletion rate, were much less likely to be cut out of a 401(k) plan's
menu than unaffiliated funds, which had a 19.1 percent deletion rate. The bias
favoring proprietary funds was particularly pronounced for poorly performing
funds, with plans removing just 13.7 percent of the funds in the poorest
performing decile, or lowest 10 percent of funds, which was much less than the
25.5 percent deletion rate for unaffiliated funds in the same bottom decile of
funds, the study showed.
The study examined 2,494 plans from 1998 through 2009,
collecting data on mutual fund companies designated as plan trustees, the menu
of investment options and amounts invested in each option from annual Form 11-K
filings to the Securities and Exchange Commission and Form 5500 filings to the
Department of Labor.
Sialm co-authored the study with Veronica Krepely Pool,
associate professor of finance at Indiana University's Kelley School of
Business in Bloomington, Ind., and Irina Stefanescu, an economist at the Board
of Governors of the Federal Reserve Board in Washington.
According to the study, the addition rate for proprietary
funds in the highest performance decile was about three times higher than for
funds in the lowest performance decile. This compared with an addition rate for
unaffiliated funds in the top performance decile that was about eight times the
rate for funds in the lowest performance decile, the study showed.
The bias toward proprietary funds in their addition to and
deletion from plan menus potentially could be negated if plan participants
steered their investments away from these favored funds, particularly the
poorly performing ones, the study said. However, the research showed that
biased menu changes rather than participant preferences appeared to be the
primary reason that participant assets heading into proprietary funds were 27
percent higher than for money going into unaffiliated funds.
Finally, the study said that the bias in menu setting toward
proprietary funds, which results in a larger share of participant money going
into proprietary funds with poor past performance, may be harmful to
Call for Transparency
Sialm said that the research clearly indicated that the
numbers comparing proprietary funds with unaffiliated funds showed a statistically
significant difference that couldn't be explained by “background noise or
chance.” Sialm conceded that he and the other researchers were examining the
data only and weren't privy to actual conversations between plan sponsors and
mutual fund companies involving mutual fund menu selections and deletions.
However, he said they could with confidence glean from the statistical analysis
of the data that plan selection was biased in favor of proprietary funds.
He said a plan's use of proprietary funds isn't always a bad
thing and many plans select fund families as their service provider based on
their confidence in the family's selection of proprietary funds. However, he
said the study showed that the result of fund company bias is causing
participants to invest in poorly performing funds that may adversely affect
employee retirement income security.
Matthew Beck, a spokesman for the Investment Company
Institute in Washington, said the study appears to be based on a fundamental
error—the notion that a mutual fund company acting as a trustee picks the funds
going into a 401(k) plan. In fact, federal law would prohibit a trustee from
picking the plan’s menu of funds in circumstances where doing so would benefit
an affiliated fund company. The fund company or its affiliates can only act as
a `directed' trustee carrying out the directions of the plan fiduciary, which
is usually the plan sponsor,” he said.
Study Out of Date?
Beck said that a plan's fiduciary, which is usually the plan
sponsor, has a duty to select the plan’s menu of investments so that the
investments selected are in the best interests of that plan's participants. The
DOL's Employee Benefits Security Administration finalized regulations in 2012
requiring plan service providers to give plan fiduciaries disclosures on their
services and compensation assessed.
Sialm said the continuing study had thus far looked at
results only through 2009, which preceded implementation of the disclosure
changes referred to by Beck, and that it was possible that more current data
would show different results. Sialm said that setting up and managing a defined
contribution plan is expensive, and that the costs of such plans are paid
either by the plan, its participants or shared by both. For many sponsors, it
may be desirable to pass much of these costs onto the plan's participants,
which can be done by using higher-cost proprietary funds, he said.
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