Does Your 401(k) Plan Contain Proprietary Investments?

One of the most common issues we find when reviewing 401(k) plans is the prevalence of proprietary investments inside the plan. A proprietary investment is one that has the same name attached to it as that of the record keeper/TPA (third-party administrator).

This is extremely common with insurance company providers as well as with the handful of mutual fund companies who are still in the record keeping business.

Is this practice illegal or unethical?  Absolutely not, but it is certainly something that you as a plan fiduciary should monitor closely. You also need to understand the history behind proprietary funds.

In the early 1990’s, many of the 401(k) platforms available to plan sponsors were through mutual fund companies. It was very typical to have an investment menu comprised entirely of that company’s funds. The revenue that they received from using their own funds enabled them to offer a “free” 401(k) plan to their clients without any billable fees.

In addition, the record keeping and trading technology at the time was not really built out to allow for a multi-fund family approach. Insurance companies, operating under a group annuity product, were among the first to offer a multi-fund platform. Then you had a few “open-architecture” mutual fund platforms that pioneered a new wave of technology and trading.

Many of the mutual fund companies that used to have their own record keeping platforms realized that the real revenue came from asset management. Most of them soon exited the low-margin record keeping world. Today, open architecture solutions are very common, but some firms still continue to utilize their own proprietary investments for one simple reason:  Revenue.

If you take a look at the menu of fund options in your 401(k) plan, and you find that a number of them are managed by the same firm that handles your record keeping, you have to ask yourself a very important question:  Do those funds occupy a slot in my plan based solely on their merit, or are they there to drive extra revenue to the provider?

In 2012, a paper written by several professors from prominent universities studied this very issue1. The goal of the paper was to find out if mutual fund companies acting as trustees of 401(k) plans displayed favoritism towards their own funds when constructing 401(k) plan fund menus.

To summarize their findings, the paper’s panel stated the following:

“…we show that 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. We find no evidence that plan participants undo this affiliation bias through their investment choices. Finally the subsequent performance of these poorly performing funds indicates that these trustee decisions are not information driven and are costly to retirement savers.”

The paper goes on in great detail to spell out the amount of underperformance of these funds, and how they arrive at their numbers. But, in essence, this independent research study arrives at findings that are no big surprise. We at RPS Plan Advisors have over 20 years experience in the retirement plan business, including time with some of the major record keepers that provided an up-close look at these types of decisions.

Since record keeping is a low margin business, these companies have to look elsewhere for their revenue. And it may come at your employees’ expense.

Certainly not all funds with the record keeper’s name on them are bad funds. Indeed, some of them have some very solid funds. But when it comes to constructing a 401(k) menu for our clients, RPS bases its decisions solely on the merit of that investment option—not the record keeper’s profit margins.

And, so should you.


1. Veronika K. Pool (Indiana University), Clemens Sialm (University of Texas), Irina Stefanescu (Board of Governor of the Federal Reserve System). It Pays to Set the Menu: Mutual Fund Investment Options in 401(k) Plans (July 2012).