Retirement plan sponsors are relying more on past performance than on future expectations when it comes to choosing asset managers or investment strategies, despite all the disclaimers that warn against doing so.
That's the finding of a new paper from the University of Oxford's Saïd Business School, which found that plan sponsors make choices based on factors that will expose them to the least liability, should investment performance be poor.
In their paper, Dr. Howard Jones of the Saïd Business School and Dr. Jose Martinez of the University of Connecticut wrote that, according to a fundamental principle of financial economics, rational investors choose their investments based on how those investments might perform in the future.
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However, the authors said, their findings reveal that institutional investors — specifically, plan sponsors — don't do that at all. Instead, they look at "the relationship between past performance and investor-directed fund flows" and consultants' recommendations to choose those who will manage fund assets. And they do so to limit their own liability should investments head south.
Thirteen years of survey data from Greenwich Associates, covering plan sponsors with half of the institutional holdings of U.S. equities, were analyzed to come up with the study's conclusions.
The study's authors considered three factors: asset managers' past performance, "nonperformance attributes" of the asset managers, and investment consultants' recommendations of asset managers. Then, they compared plan sponsors' expectations and the drivers for those expectations against the actual future performance of those asset managers. Finally, sponsors' expectations, asset manager performance, past performance, consultant recommendations and other factors were compared against those asset managers fund inflows and outflows.
Among the study's conclusions is that plan sponsors' "actions are at variance with their own expectations (of asset allocations' future performance) because they feel that past performance and consultants' recommendations are a more defensible explanation for their decisions to their superiors and other stakeholders."
"The irrelevance of fund managers' past performance in predicting future performance has long been recognized, but pension funds continue to allocate assets as if it matters," said Jones.
"Likewise, there is no evidence that consultants' recommendations have predictive power, and yet pension funds follow them closely when allocating funds," he said. "We find that this is not because pension funds naively extrapolate future performance from these indicators.
"The most likely explanation is that pension funds use past performance and consultants' recommendations to duck responsibility in case they choose fund managers who perform badly."
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