Swedroe: Plan Sponsors’ Weak Returns

January 26, 2015

Extra Effort And Sophistication Not Worth It

Compared with individual investors, institutional plan sponsors have a much higher level of investing sophistication. They are typically staffed with professionals that have years of experience and advanced degrees.

 

Either on their own, or through the use of consulting firms such as SEI, Russell and Goldman Sachs, institutional plan sponsors devote considerable time and resources to selecting asset classes and products that are expected to perform well in the future. Yet the record demonstrates that their efforts have proven counterproductive.

 

If they fail with such persistence, what are the odds that you, or your financial advisor, will do any better? What logical reason can you come up with to justify trying to outperform appropriate risk-adjusted benchmarks when others with more resources and time have failed?

 

More Damning Research

Unfortunately, the experience of 401(k) plan sponsors isn’t any better. The authors of the 2013 study, “How Do Employers’ 401(k) Mutual Fund Selections Affect Performance?” took a look at the performance of plan administrators through their fund selections.

 

They found the mutual funds that plan administrators choose underperform benchmark index funds.

 

Thus, participants would be better served if the plans offered passive, instead of active, fund choices. They also found that plan administrators are performance chasers—they fire poorly performing funds and replace them with the “hot” funds at the time. However, all of this activity didn’t add any value.

 

Why Keep Repeating The Same Mistakes?

The question then remains: Why do plan sponsors keep doing what Einstein described as the definition of insanity—repeating the same behavior over and over and expecting different results? Why do they keep hiring managers who have delivered alpha in the past only to end up firing them because the past isn’t prologue?

 

The authors of one study hypothesized that it occurs because plan sponsors find comfort in extrapolating past performance, despite their own experiences that demonstrate excess performance is random.

 

Stakes Are High

Perhaps the real answer is that plan sponsors need to justify their existence. If they recommended abandoning active managers and instead chose passively managed funds and adhered to their asset allocation plan, many would no longer be needed.

 

One of our most famous economists, Paul Samuelson, put it this way: “[A] respect for evidence compels me to incline toward the hypothesis that most portfolio decision makers should go out of business—take up plumbing, teach Greek, or help produce the annual GNP by serving as corporate executives. Even if this advice to drop dead is good advice, it obviously is not counsel that will be eagerly followed. Few people will commit suicide without a push.”

 

The issue of the performance of plan sponsors is of great importance, given the dollars involved. In addition, in the case of public plans, future taxpayers will have to bear the burden of losses incurred by plan sponsors. It’s past time for the process of selecting investment managers by plan sponsors to change.


Larry Swedroe is the director of research for the BAM Alliance, a community of more than 150 independent registered investment advisors throughout the country.

 

 

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