Mutual fund families, despite serving as retirement plan fiduciaries and hosting “open architecture” plans, nevertheless favor their own fund offerings, according to new research.
In an academic paper published late last month, Veronika Krepely Pool and Irina Stefanescu, both of Indiana University, and Clemens Sialm of the University of Texas at Austin say that poorly performing funds are more likely to appear on 401(k) menus if they are affiliated with the plan trustee.
Titled It Pays to Set the Menu: Mutual Fund Investment Options in 401(k) Plans, the study eliminates the possibility that trustees maintained a proprietary fund on the plan menu because of information that the fund was poised to outperform, since subsequent performance was disappointing.
In fact, the reseachers found that trustee-affiliated funds underperformed by an annual 3.6% on a risk-adjusted basis, thus having a significant impact on retirees’ retirement income—especially considering compounded return effects. Moreover, the study determined that investors do not undo the bias toward the trustee’s funds through their investment choices.
The problem stems from an inherent conflict of interest between a fund company’s role as trustee of a retirement plan and its self-interest in promoting its own products.
ERISA regulations tolerate this conflict by requiring trustees to be “prudent” in selecting “suitable” investments.
Write the study’s authors: “We hypothesize that if the trustees' decisions are driven by their own financial interests, mutual fund trustees may be more inclined to include their own funds in the fund lineup—even when more suitable options are available from other fund families—and subsequently more reluctant to remove them.”
Using a large sample of data based on SEC 11-K filings over an 11-year period, the study’s authors compare fund option choices among fund family trustees and non-mutual fund trustees. The authors write:
“An interesting feature of our dataset is that a given fund often contemporaneously appears on several 401(k) menus that are administered by different trustees … and allows us to contrast how the very same fund is viewed across two different menus: one on which it is a trustee fund and another on which it is not.”
The researchers find that trustees favor their own funds, and are far more forgiving of poor performance.
“For example, mutual funds ranked in the lowest decile based on past performance…are approximately two and a half times more likely to be deleted from those menus on which they are unaffiliated with the trustee than from those where they are affiliated with the trustee.”
The three researchers make clear that their paper does not address whether or not plan sponsors should employ mutual fund companies as plan trustees and call for additional research that explores the costs and benefits of having mutual fund and non-mutual fund companies managing these plans.
Under current ERISA law, an employer sponsoring a retirement plan appoints a trustee to hold the plan’s assets. That trustee has a fiduciary responsibility to manage the plan for the benefit of plan participants, acting within reasonable standards of prudence and offering diversified investment options.