“Set it and forget it” just took on a nefarious new meaning according to recent research from three college professors. The academics report that long time horizons inherent in target-date products mean most investors aren’t focused on the returns in their retirement accounts. It’s something target-date managers are fully aware of, and also exploit, causing underperformance in a TDF investment’s glide path early on.
Massimo Massa with INSEAD, Rabih Moussawi with Villanova University and the University of Pennsylvania, and Andrei Simonov with Michigan State University write that it all stems from a lack of immediate need on the part of retirement plan participants.
“We study how managers of funds created to invest for the long run behave when shielded from liquidity constraints and their investors’ short-term needs,” according to the study. “Using the universe of all U.S. target-date funds (TDFs), we directly test whether extending the horizon is beneficial for investors’ optimal portfolio allocation or whether it allows asset managers to use it as a shield to put in place policies detrimental to investors.”
As one would guess, it’s the latter.
“Investor attention is lower when a TDF is further away from the target horizon,” the authors write, and their analyses suggest that exploit this lack of focus to underperform, “around 2.9 basis points for each year of distance from the target horizon.”
High costs over time
The result is not insignificant, adding up to -21% for an investor holding the fund for 50 years.
“The negative impact on performance is more pronounced for retail funds when investors are less sensitive to performance, and in families with higher flow volatility when the fund family has a greater need to use the TDFs, it manages to smooth performance,” they add.
“The longer the horizon, the higher the total fees the asset managers charge, partly because TDFs invest in more expensive fund share classes of underlying funds,” the authors conclude with a parting shot at the PPA. “We use the Pension Protection Act of 2006 as an exogenous shock that allowed firms to offer TDFs as default investment options within 401k retirement plans.”
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
