A new study reveals that service providers to 401(k) plans aremuch more likely to add their own proprietary mutual funds to planlineups, and far less likely to remove them, even when theirperformance lags.

The favoritism is actually most glaring when comparing theworst-performing proprietary mutual funds with funds not affiliatedwith service providers, according to theresearch, which was authored by two academics and an economist withthe Board of Governors of the Federal Reserve System.

About 25 percent of non-affiliated mutual funds that ranked inthe lowest 10^th percentile of performance over athree-year period were removed from investment menus.

But service providers only removed 13.7 percent of their ownworst-performing funds.

“Protecting poorly-performing funds by keeping them on the menuhelps mutual fund families to dampen the outflow of capitaltriggered by poor performance and, as a result, mitigates funddistress,” according to the paper, which was released by thePension Research Council, the research group affiliated with theWharton School of Business.

Service providers’ “menu favoritism” affects participantoutcomes, as the research shows participants are generally not awareof poor performance or service providers’ bias toward their ownmutual funds.

And that has “important implications for the employees’ incomein retirement.”

The study examined 2,494 plans offered by 1,826 sponsors between1998 and 2009. Average plan size was $324 million. In 2009, theplans covered nine million participants with $400 billion inassets.

About 76 percent of the plans had service-provider trusteesaffiliated with mutual fund companies.

The three largest service providers in the study — Vanguard,Fidelity, and State Street — each manage over 10 percent of all401(k) mutual fund assets.

Even for large plans, the study found the tendency to removenon-affiliated mutual funds to be higher than proprietary funds.

“Overall, our baseline results indicate that affiliated fundsare significantly less likely to be deleted from 401(k) plans thanunaffiliated funds and that this bias is particularly pronouncedfor poorly-performing funds,” write the authors.

“While service providers of 401(k) plans are expected to act inthe best interest of participants, they also have a competingincentive to attract and retain retirement contributions in theirown proprietary funds,” concluded the authors.

Too little is known about how provider incentives influencechoices offered in 401(k) plans, they said.

And more should be done to understand the ramifications of fundfavoritism, “as small inefficiencies in the selection ofinvestments options, especially early in the participants’ career,can have a significant impact on retirement savings outcomes.”