The practice of revenue sharing in retirement plans is equal parts complicated and controversial, and a new working paper published by the National Bureau of Economic Research is bound to add fuel to the fire.
According to the paper, 401(k) plans that utilize mutual fund revenue sharing as a method of paying for recordkeeping fees and other administrative services are more expensive on average, and the higher expense ratios are not offset by lower direct fees or by superior performance.
The NBER paper was penned by Veronika Pool of Vanderbilt University; Clemens Sialm of the University of Texas at Austin's McCombs School of Business; and Irina Stefanescu, principal economist of the Federal Reserve Board.
In sum, the authors find revenue-sharing plans are more expensive and fail to deliver superior net-of-fee performance. Furthermore, the authors show the amount of rebates tends to increase with the market power of the recordkeeper — suggesting that third-party funds may purposefully utilize revenue-sharing arrangements to gain access to retirement assets.
A Source of Fierce Debate
As Pool, Sialm and Stefanescu write, retirement plans are among the most important distribution channels for mutual funds, accounting for approximately two-thirds of the entire $7.7 trillion invested in 401(k) plans in 2021.
As the analysis explains, the same companies that provide mutual fund families are often hired by employers sponsoring 401(k) plans as "recordkeepers," and they are tasked with helping to establish and administer the set of investment options offered to participants.
The authors posit that 401(k) plans typically adopt an "open architecture" investment approach, whereby the menu includes third-party investment options along with options affiliated with the recordkeeper. Within such arrangements, recordkeepers typically collect compensation through a mix of direct and indirect payments. Often, indirect payments occur in the form of rebates made by third-party mutual funds to the recordkeeper.
Such rebates arise, for example, when third-party fund expense ratios include a charge for administrative services, though these services are outsourced to the plan recordkeeper. According to the authors, if direct and indirect payments do not offset each other, recordkeepers may collect more revenue in the presence of indirect compensation and participants may pay higher fees in their retirement plans.
Additionally, if recordkeepers are better off when they receive compensation indirectly, the paper suggests, they may influence 401(k) sponsors to include (and subsequently keep) funds on the menu that pay a higher rebate.
