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Attracting Flows by Attracting Big Clients

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 Lauren Cohen and Breno Schmidt

We document a new, economically large, and growing channel, for attracting assets under management: namely the 401(k) market.  In 2004, nearly 40% of all mutual fund assets were held by Defined Contribution Plans and Individual Retirement Accounts. This percentage is steadily increasing largely because these retirement accounts represent the majority of new flows into non-money market mutual funds (60% in 2004).  With such a large and growing percentage of their assets coming from retirement accounts, mutual funds are likely to be interested in securing these big clients. Previous literature on the agency problems associated with increasing funds under management has concentrated on the flow performance relationship. In this paper we examine a new channel through which mutual fund families can attract assets: by becoming the trustee of a 401(k) plan.

Families secure substantial inflows by being named trustee. We find that family trustees significantly overweight, and are reluctant to sell, their 401(k) client firm’s stock. Trustee overweighting is more pronounced when the relationship is more valuable to the trustee family, and is concentrated in those funds receiving the greatest benefit from the inflows. We quantify this flow benefit to mutual funds and find that inclusion in the 401(k) plan has an economically and statistically large, positive effect on inflows.

As the percentage of mutual fund assets held by defined contribution retirement plans steadily increases, we expect these 401(k) plans to become more important sources of growth for fund families. Indeed, following the passage of the Pension Protection Act of 2006, projections estimate that 401(k) participation rates will increase by nearly 50% in coming years, vastly increasing the size of 401(k) plans. We therefore predict the importance of the trustee relationship on mutual fund portfolio choice that we document here to increase in coming years.

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