High-revenue-sharing funds are more likely to be added to the investment menu of 401(k) plans, are less likely to be deleted and participants face significantly higher fees, according to an updated study.
In SSRN’s “Mutual Fund Revenue Sharing in 401(k) Plans,” Veronika Krepely Pool of Vanderbilt University, Clemens Sialm of the University of Texas at Austin and National Bureau of Economic Research, and Irina Stefanescu of the Board of Governors of the Federal Reserve System, contend that revenue-sharing plans are more expensive as higher expense ratios are not offset by lower direct fees or by superior performance.
In noting that small differences in fees or inefficiencies in the selection of investment options can have a large impact on retirement savings outcomes, their paper seeks to address how provider incentives influence the characteristics of the investment choices offered in plans and their effects on 401(k) plans.
To investigate, the researchers use data on mutual-fund level revenue sharing, which they note became available in 2009 when the Department of Labor extended reporting requirements on these arrangements. They hand-collect menu options for the 1,000 largest 401(k) plans in the U.S. from 2009 to 2013 from annual plan-level Form 5500 disclosures to, among other things, examine the relationship between revenue sharing and menu design.
The researchers contend that high-revenue-sharing funds are favored by plans and that rebates increase with the market power of the recordkeeper, suggesting that third-party funds may utilize revenue sharing to gain access to retirement assets.
“We find that funds that revenue share are economically and statistically significantly less likely to be deleted from revenue-sharing plans,” the researchers note. For example, they find that the average deletion rate is around 20% for revenue-sharing plans and 28% for non-revenue-sharing plans. “When we replace the revenue-sharing indicator with the magnitude of the revenue share, we find that funds that pay a higher rebate are significantly less likely to be deleted,” they add, further noting that these results also hold within the same fund year.
Indirect compensation arrangements are common in their sample period among the largest 401(k) plans in the U.S. In approximately 54% of the plans studied, recordkeepers received a rebate in the form a revenue-sharing arrangement from at least one fund on the menu.
“Our results are consistent with the notion that these less transparent indirect payments allow recordkeepers to extract additional rents from plan participants,” Pool, Sialm and Stefanescu write.
Additionally, the study shows that about 55% of third-party, unaffiliated funds in revenue-sharing plans offer revenue-sharing rebates on average. Among the unaffiliated funds that revenue share, the average rebate is about 18 basis points. Further noting that expense ratios are higher for revenue-sharing funds, the researchers observe that this result also holds within a fund, suggesting that the same fund will use a higher expense ratio share class in plans where the rebate is higher.
The researchers also find that funds that tend to revenue share on other menus and tend to pay higher rebates are significantly more likely to be added to revenue-sharing plans. For example, the study notes that funds with an above-median propensity to revenue share have an average addition rate of 0.16%, whereas funds with a below-median propensity have an average addition rate of 0.10%.
“Our results indicate that rebates do translate into higher expense ratios in the retirement setting while direct fees are not significantly different across revenue-sharing and non-sharing plans,” Pool, Sialm and Stefanescu write. Consequently, they note that participants face higher all-in fees in revenue-sharing plans.
“Taken together, these results reveal the complex nature of indirect payments in 401(k) plans,” the researchers conclude, suggesting that “revenue-sharing arrangements not only reflect a contractual agreement between the plan and the recordkeeper, but also between the recordkeeper and the third-party management companies on the menu.”
