Study Shows Openness Needed on 401(k) Options, Co-Author Says

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By David B. Brandolph

Aug. 17 — 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.

The study also showed that the plans' decisions to add funds to their investment menus were less dependent on the investment performance of the funds for proprietary funds that were added to plan menus than for unaffiliated funds that were added.

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 participant savings.

Matthew Beck, a spokesman for the Investment Company Institute in Washington, said that while “we are unable to speak to the data presented, 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.

Call for Transparency and Education 

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.

Sialm said that the study shows that plan sponsors need to be doing a better job of monitoring the funds that are added to and deleted to their plan menus to assure that better-performing and lower-cost funds are being selected while lesser-performing and higher-cost funds are being deleted.

Sialm also said participants need more transparency and education regarding the relationship between their plan and mutual fund company service providers, including accurate information about how much they are paying for each fund in which they invest.

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.

Further, he said, “plan sponsors have a number of options available—they can select an administrator that only does record keeping or one that bundles record keeping with investment options, either in closed or open platforms.”

Beck said that “recent disclosure reforms from the Department of Labor have greatly improved employers’ access to the information they need for simple, clear comparisons of record keeping and asset management options so they can make the decision that best suits their plan.”

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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To contact the editor responsible for this story: Phil Kushin at

The study can be found at