CFA Institute Journal ReviewFebruary 2017Volume 47Issue 2
It Pays to Set the Menu: Mutual Fund Investment Options in 401(k)
Plans (Digest Summary)
Veronika K.PoolClemensSialmIrinaStefanescuJournal of Finance
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Mutual fund management companies that provide services to sponsors of 401(k) savings
plans exhibit favoritism toward their own affiliated funds. Underperforming affiliated
funds are less likely to be removed from the menu of available investment options compared
with similarly underperforming non-affiliated funds. The investment choices of plan
participants tend to suggest that they are unaware of the potential conflicts of interest
involved and continue to invest in underperforming investment options.
How Is This Research Useful to Practitioners?
Mutual fund service providers benefit from the inclusion of affiliated funds on investment
menus via the capture of fees that tend to be asset based. In contrast, revenue-sharing
arrangements are typically used for non-affiliated funds. Taking a wider perspective, a
predominance of affiliated funds on a service provider’s investment menu increases
the likelihood that a long-term relationship may develop between the service provider and
the plan participant that could lead to future cross-selling opportunities. Historically,
corporate sponsors may also have benefited from lower costs by selecting service providers
that offered predominantly affiliated funds; however, regulatory changes have led to an
increasing number of non-affiliated funds being available for plan participants to invest
Over the period of the study (1998–2009), the authors find that funds affiliated with
the mutual fund service provider are less likely to be deleted compared with non-affiliated
funds, irrespective of fund performance. Similarly, affiliated funds are more likely to be
added than non-affiliated funds. These results are robust after allowing for such
explanatory variables as fund performance, fund correlations, expense ratios, and fund
The authors also confirm earlier studies that show that recent fund underperformance is not
an indicator of a subsequent rebound in performance. These findings suggest that retaining
an underperforming affiliated fund in hopes of a performance rebound is likely to lead to
poor outcomes for plan participants but is beneficial in protecting revenues for the service
This research is particularly useful for plan sponsors and their advisers (e.g., asset
consultants) when establishing and monitoring 401(k) plans for their employees, because it
highlights the potential conflicts of interest faced by the mutual fund service providers
that they appoint.
How Did the Authors Conduct This Research?
The authors collect information about the investment options in 401(k) plans from the Form
11-K filed with the SEC. This filing provides plan details, including plan description,
trustee, investment options offered, and the accumulated asset values across each of the
investment options. This form is filed for plans that offer the stock of the sponsoring
company. Only data for companies listed on Compustat are included in the final dataset.
The SEC data are then merged with data from the CRSP Survivorship Bias-Free US Mutual Fund
database. These data include details on fund performance and expense ratios of the various
investment funds and allow for the classification of funds into such style categories as
“domestic equity” and “balanced.”
The authors then perform a univariate analysis of funds that were added and deleted and
find that affiliated funds are less likely to be removed from investment menus than
non-affiliated funds, irrespective of performance.
Logistic regressions are then run to determine whether such explanatory variables as
investment performance over the past three years, investment style, intra-fund correlations,
fund size, turnover, and expense ratio influence the differences in deletion rates for
affiliated and non-affiliated funds. Various measures of performance are used as
conditioning variables, including raw performance percentiles and classifying funds as above
or below median performance. The impact of fund size on the probability of deletion is also
considered. The authors then perform a similar analysis for fund additions.
Using a regression-based approach, the authors investigate differences in the flow of funds
for affiliated and non-affiliated funds and find that affiliated funds tend to benefit by
avoiding large outflows from their poorly performing funds.
The data used by the authors cover 1998–2009. Subsequent improvements in technology,
improved investor protections, and higher expectations of both plan sponsors and plan
participants may have led to improvements in plan designs that reduce the apparent conflicts
of interest that had previously existed.
Potential conflicts of interest abound in the investment management industry, with the
identification of an optimal mix of investment funds suitable for corporate plans being a
In some jurisdictions, these conflicts are managed by the segregation of the
“manufacturing” role played by fund management professionals within the firm
and the “fiduciary” role played by internal trustees appointed to look after
the interests of plan sponsors and plan participants.
Plan sponsors (and their advisers) need to balance the headline benefits of lower fees from
selecting predominantly affiliated funds versus the potential (but non-guaranteed) higher
returns from possibly more expensive, specialized external managers. In the current
low-growth environment, a focus on lower fees tends to favor affiliated funds, in which
overall costs may be lower.
Although a potential solution is simply to broaden the range of available investment
options, previous studies have shown that too much choice can lead to confusion and inaction
for investors. Investor education offered by the service provider may favor affiliated
funds, which simply leads back to a similar set of conflicts.
Finally, it would have been interesting to investigate whether the findings are relatively
uniform across the major mutual fund service providers or whether some providers exhibit
greater biases than others, noting that the data are relatively old and may no longer apply
to the service providers identified.