Although defined contribution (DC) pension plan participants rarely adjust their retirement portfolio allocation, participants’ inertia is offset by DC plan sponsors that adjust the plan’s investment options. As a result, flows into mutual funds from DC retirement accounts are more volatile and exhibit more performance sensitivity than non-DC flows.
What’s Inside?
The authors analyze the behaviors of defined contribution (DC) plan participants (i.e., employees) and plan sponsors (i.e., employers) in the United States and try to determine how the behavior of these two entities affects the flow of money from DC retirement accounts to mutual funds (i.e., whether DC pension plan investment constitutes a source of sticky or discerning money for mutual funds).
How Is This Research Useful to Practitioners?
DC plan assets constitute 23% of total US mutual fund assets and 27% of US equity fund assets. Total assets within DC plans were $5.7 trillion as of 2013 (versus $1.7 trillion as of 1995), according to the 2014 Investment Company Fact Book and the Investment Company Institute Annual Report. This number is expected to continue to increase as more employers embrace DC plans instead of defined benefit (DB) plans. Given the size of DC plans and their likely impact on asset prices, a better understanding of who/what drives the investment choices of DC plan retirement money is beneficial to fund managers, especially mutual fund managers.
Conventional wisdom has held that DC plan assets in mutual funds should be sticky and not discerning. There are two main reasons for this belief: (1) DC plan participants make periodic retirement contributions and withdrawals, which are persistent over time; and (2) DC plan participants have long investment horizons. As such, the prevailing wisdom has been that DC retirement money flow is sticky and does not get influenced by fund performance, at least in the short run.
The authors’ findings do not support this conventional wisdom. When they compare the flows of DC and non-DC mutual fund investors, they find that money flows into mutual funds by DC plan participants are more volatile, and hence less sticky, than the flows into mutual funds by other investors. Moreover, DC retirement money flows are more sensitive to prior fund performance than non-DC flows. Last but not least, the authors’ findings indicate that non-DC flows predict long-term performance negatively; for DC flows, there is no significant predictability of future performance that suggests that DC flows are more “discerning.” This volatility in terms of DC retirement money flow is driven by plan sponsors that are guided by fiduciary responsibility and adjust plan choices of mutual fund according to prior fund performance.
How Did the Authors Conduct This Research?
To determine the difference, if any, between the volatility of DC plan and non-DC plan retirement money, the authors compare the flows of DC and non-DC money into mutual funds. They use several data sources for their analysis to compile data on mutual funds holding DC money. Using the time period of 1997–2010, they obtain data from annual surveys conducted of mutual fund management companies to determine the 12 funds with the most DC assets in each of several broad investment categories. They also use data from Form 11Ks filed by plan sponsors with the SEC. The authors then separate the mutual fund data to obtain DC flows and non-DC flows.
Abstractor’s Viewpoint
Given that more and more employers are embracing DC plans instead of DB plans and increasing the assets under DC plans, the authors’ research is timely. They shed new light on who or what drives the volatility of money flow under DC retirement plans.