If you have money in a 401(k) plan, it's unlikely you know the plan has trustees, let alone who they are and who they work for. You should, because their presence might well be costing you money. According to a new study, 401(k) plans favor mutual funds in some cases where plan trustees are affiliated with those mutual funds. Sometimes, the study says, the inclusion of these funds in the plan costs investors money. Other 401(k) plans with trustees who were not affiliated with mutual fund companies did not exhibit similar favoritism.
The study, by academics at Indiana University and the University of Texas, claims to be the first to look at the conflicting roles of 401(k) plan trustees who are affiliated with mutual fund companies. Trustees are appointed by the employers who sponsor the plan. Many of them are affiliated with the mutual fund companies whose funds are offered in the 401(k) plan they help oversee. Federal law says they are supposed to put the interests of employee investors first.
Veronika K. Pool, an assistant professor of finance at Indiana University and the lead author of the study, says the research makes no assumptions about whether trustees affiliated with mutual fund companies either selected or even tried to influence the selection of their funds by the plan. A spokesman for the Investment Company Institute, the major mutual-fund trade group, says representatives have not read the study and thus have no immediate comment on its findings.
Using public U.S. Securities and Exchange Commission (SEC) filings spanning more than a decade, the researchers looked at a large number of plans, including some with trustees affiliated with mutual fund firms and some with trustees who had no relationship with a fund company. Many of the same mutual funds were offered in both types of plans. By studying how the two groups of plans treated the same funds, the study found that plans with mutual-fund affiliated trustees tended to favor their own mutual funds, and were particularly reluctant to drop their poorly performing funds from the plan. "Poorly-performing funds are less likely to be removed from and more likely to be added to a 401(k) menu if they are affiliated with the plan trustee," the study said.
"The biggest difference between how trustee and non-trustee funds are treated on the menu occurs for the worst performing funds," the authors wrote. Looking at the worst-performing 10 percent of funds, the study found that plans with independent trustees were two-and-a-half times more likely to drop such funds from the plan than were plans with trustees who had an affiliation with the funds.
The study said plans with mutual-fund affiliated trustees were also "substantially more likely" to enter those mutual funds in the plan, even though their additions had poorer historical performance records than the funds added by independent trustees.
Of course, if a plan tilted toward lower-performing funds, employees participating in the plan always have the option of looking at the relative performance of all their fund choices. They then could sell poor performers and buy better ones. Only they don't, the researchers said. "Participants are generally not sensitive to poor performance and thus they do not undo the trustee bias," the study said.
One reason plans with mutual-fund affiliated trustees might favor those funds, the researchers suggested, is because the trustees know the funds very well. Even if a fund had been performing poorly, their decision to use it might be tied to fund trustees' assessment of attractive future performance. Only this didn't happen, either. In fact, such funds continued to perform poorly.
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"Trustees' resistance to remove their own poorly performing funds generates a significant subsequent negative abnormal return of 2.9 percent to 3.6 percent per year for participants investing in those funds," the study concluded. Shaving 3 percent from a fund's returns each year can have a large cumulative effect over time.