Bias Influences 401(k) Plans’ Investing Offerings

When mutual fund companies are asked to help manage defined-contribution plans and set the menu of investment offerings, they often favor their own funds.

A bias exists in the investments offered in 401(k) and other defined-contribution retirement plans. When mutual fund companies are asked to help manage defined-contribution plans and set the menu of investment offerings, they often favor their own funds. The Center for Retirement Research reached this conclusion in a study scheduled to be published in the Journal of Finance.

The study analyzed the funds offered by nearly 2,500 plans for the years of 1998 through 2009. Combined, these plans held one-third of 401(k) assets in plans sponsored by publicly traded companies. Most of these had an “open architecture format,” which included funds from companies unaffiliated with the mutual fund company managing the plan.

Performance was less likely to be a factor for affiliated funds (those offered by the mutual fund family managing the 401(k) plan) than it was for unaffiliated funds (those offered by other mutual fund companies). Affiliated funds were three times more likely to be added if their three-year returns ranked in the top 10% of their category than if performance ranked in the lowest 10%. Unaffiliated funds were held to a higher performance standard, as funds ranking in the top 10% were eight times more likely to be added than those ranking in the bottom 10%.

Similar bias was evident among deletions from plan menus. Just 13.7% of affiliated funds with three-year returns ranking in the bottom 10% were removed. In contrast, 25.5% of unaffiliated funds ranking in the bottom 10% were removed. Even when performance was not specifically accounted for, unaffiliated funds had significantly higher deletion rates (19.1% versus 13.7%).

Plan participants could, of course, ignore the biases and choose the best funds. The study’s authors say this does not happen, however. Rather, plan participant decisions “are not very sensitive to past performance, especially for affiliated funds with below-median returns over the preceding three years.”

Source: “Are 401(k) Investment Menus Set Solely for Plan Participants?,” Veronika K. Pool, Clemens Sialm, and Irina Stefanescu, Center for Retirement Research at Boston College Brief, August 2015, Number 15-13.