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Positives and Pitfalls of Proprietary Funds

How is your 403(b) invested? Are any of its assets invested in proprietary funds? If so, says a recent blog entry, you are not alone — and there are ways to blunt criticism some may levy against that.

In “Proprietary Funds: The New Lightning Rod for 403(b) Plans?,” a recent entry in Cammack Retirement’s “Top of Mind” blog, Michael Webb observes that proprietary funds certainly have their detractors, but that there are advantages to their use, as well as ways to respond to their critics.

So what to the detractors say? Chief among their criticisms is that there is a conflict of interest when a plan’s recordkeeper offers a proprietary fund in which the plan invests assets. But such an arrangement is not pure evil, Webb argues. This, he says, is because:

  • For most large 403(b)s, it is not required that a plan’s funds be invested in a proprietary fund — it’s optional.

  • Most 403(b) assets are held in individual accounts and custodial arrangements that individual participants control, and the plan sponsor cannot move funds into a proprietary fund even if it wanted to.

  • Participants sometimes greatly favor and are loyal to a particular proprietary fund, and a plan would be wise to consider the effect on employees and possible disruptions if it were to divest of such a proprietary fund.

“Any plan sponsor who selects/retains a proprietary fund (or funds) in their investment array is likely going to need to defend that decision at some point. The good news is that this should be fairly straightforward for plans with a written investment policy,” writes Webb. “The question here is simple: per the fund selection/retention criteria of the plan’s investment policy, would the proprietary investment be selected/retained if the investment were not proprietary,” he concludes.