Swedroe: Plan Sponsors’ Weak Returns

January 26, 2015

Institutional plan sponsors are charged with investing trillions of dollars on behalf of pension plans, endowments and foundations. As a result, the quality of the investment decisions made by these plan sponsors is of great interest and importance to a great many people.


Over the years, I’ve met with many institutional plan sponsors to discuss their investment strategy. These plan sponsors all have a fiduciary duty to their beneficiaries, and they take their jobs seriously. In my experience, they also all believe they are adding value through their investment decisions.


Are they right? Unfortunately, the evidence demonstrates that their decisions persistently destroy value.


Taking A Deep Dive

A recent study, “Absence of Value: An Analysis of Investment Allocation Decisions by Institutional Plan Sponsors,” examined whether investment decisions made by institutional plan sponsors contribute to their asset values. The study used a data set covering 80,000 yearly observations of institutional investment product assets, accounts and returns over the 24-year period from 1984 through 2007.


The study covered a broad spectrum, and included both domestic and international equities as well as domestic and international bonds. The results are shocking, though they won’t surprise believers in the efficiency of markets. Following is a summary of the authors’ findings:

  • While plan sponsors may believe they are acting in their stakeholders’ best interests, the results show that when they make rebalancing or reallocation decisions, on average, they are destroying value.
  • Investment products receiving contributions subsequently underperform products experiencing withdrawals over one-, two- and three-year periods.
  • For investment decisions among equity, fixed-income and balanced products, most of their underperformance can be attributed to product selection decisions, as opposed to asset allocation decisions. However, both types of decisions subtracted value.
  • Much like individual investors, who tend to switch mutual funds at the wrong time, institutional investors don’t appear to create value from their investment decisions.


Quantifying Losses

The authors estimated that allocation decisions resulted in losses of more than $170 billion over the period studied —an average cost of more than $7 billion a year. Even this horrific figure understates the true damage, because it’s gross of any transition costs.


Clearly, plan beneficiaries would have been better served if plan sponsors hadn’t acted at all. And even more of them would likely have come out ahead if they’d simply chosen passively managed funds in the first place, and then stayed the course.


It’s worth noting that the plan sponsors were acting in what most people would agree was a rational way.


In their hiring decisions, plan sponsors placed great importance on historical performance measures, performance trends and product attributes. However, despite hiring managers with large, persistent and even long-term records of delivering alpha relative to appropriate benchmarks, their results demonstrate that relying on past performance is costly.



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