The Markets February 8, 2007

Post-Holiday Surges Lift Transfer Volumes Higher

While “inert″ participants seem to be the order of the day, those inclined to direct activity in their 401(k) accounts entered the New Year in a mood for trading.
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According to the Hewitt 401(k) index, they did so by reversing a trend that favored fixed-income for much of 2006, and in January transfers favored equities on 60% of the trading days (see International, Lifestyle Funds a Hot Spot in Quiet Trading Year).
They also did so in volume – in the process racking up three “high’ volume trading days, where the trading volume ranged from .07% to 0.13% of total balances (the latter, which was nearly 4 times the normal volume, took place on January 3, and may represent a backlog of trading orders placed over the New Year’s market holidays. Another high trading day came just after the MLK holiday, where the market was also closed for a three-day holiday), and two “moderate’ volume days. Those five “above normal’ volume days compare with an average of just two a month during 2006.
Although net transfer activity in January was still modest, with 0.04% of balances transferred daily, this was the highest monthly transfer activity since July 2006, according to Hewitt (see 401(k) Participants Flock to Fixed Income in June).
International “Intrigue”
Once again, International funds proved to be the strongest draw, received the largest inflows among all asset classes, and constituting more than a quarter of all incoming transfers. Large US equity drew another 22%, and lifestyle/asset allocation offerings benefited from more than one-in-five dollars changing funds, some $135 million for the month.
Company stock holdings funded most (62.52%) of the outward movement, with much of the rest coming from GIC/Stable value offerings. More than $407 million shifted out of company stock on a net basis during the month, according to Hewitt, and more than $201 million flowed out of GIC/stable value and money market funds.
Despite those trends, participant contributions – which tend to be less-responsive to market conditions – continued to flow to GIC/Stable Value, drawing nearly 16% of the monthly contribution flow. However, participant contributions remained most committed to large US equity funds, which pulled 22.6% of those dollars, followed by lifestyle funds (15.16%). The obvious allure of international funds among transferring participants notwithstanding, the category drew only about 11% of monthly contributions. Meanwhile, company stock, despite its healthy representation in the outbound transfers category, continued to draw 9% of the monthly contribution inflows directed by participants (and more than 27% of contributions, including employer-directed monies).
Still, at month-end, large US equity was the dominant asset holding, constituting 21.52% of the balances tracked by the Hewitt 401(k) index, while GIC/stable value represented 20%, and company stock was a nearly equal 19.7%. The “hot’ transfer categories of international and lifestyle offerings represented only about 9% and 8% of the total pool, respectively.
The Markets February 8, 2007

Bad Behaviors Thwart Performance

Recent research from UBS Global Asset Management suggests that when individual investors pursue performance over portfolio discipline, they underperform the market – and their own investments.
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Frequently, the average individual investor’s performance (what an investor actually earns over that period) is much lower than the actual investment performance (the stated return) of his holdings—sometimes as little as half as much—and the variable seems to be the investor’s behavior, according Brian Singer, Regional Chief Investment Officer, Americas, and Head of the Global Investment Solutions (GIS) team for UBS Global Asset Management. The results were published in the first quarter 2007 edition of Current Perspectives, UBS Global Asset Management’s investment newsletter.

Taking a page from behavioral economics, Singer concludes that real-life underperformance stems not from what the investments did, but rather what the investor did. “The key variable appears to be how the investor behaved: when—and why—he bought and sold his investments,” the report says.

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Institutional Investors

Although Institutional investors fare better, they are not free of all criticism. Institutional investors use greater discipline in their investment processes than do individual investors but, according to the research, they often follow their own form of performance-chasing, particularly in seeking “alpha,” or returns uncorrelated to a benchmark.

Singer says that the most frequently requested data series from institutional investors is the three-year historical track record, relative to the benchmark. “Almost every RFP requests this information, and we are dumbstruck by the degree to which it is used as an initial screen…. The reasoning is that three years is enough time to analyze a manager’s returns, and provides evidence that helps assess whether the manager is indeed skillful at beating a benchmark,’ the research says.

However, the report continues, three-year trailing performance is actually a fairly good contra-indicator of three-year prospective performance.

Adviser Actions

This research reinforces the importance of disciplined portfolio construction and, in fact, “a firm might conduct the best manager research since the invention of sliced bread, but if there is a lack of fiduciary accountability and the discipline to combine these managers for long-term performance, I believe the efforts are neutral at best, and destructive of value at worst,’ Singer says.

“I am pointing out how destructive both total-return-chasing and excess-return-chasing behavior can be,’ Singer says in the article. Therefore, he suggests, “the best offense may be a good defense,’ and tells advisers they can:

  • Create an outcome-oriented neutral portfolio allocation, based either on the investor’s risk tolerance or liability needs, or both
  • Adopt a theoretically sound core set of investment beliefs and stick to them
  • Appropriately define, understand, measure and manage risk
  • Not rely too much on historical performance, especially observed over short periods of time.

Although this advice appears logical, “putting them into practice may be harder than you think—for individuals and institutions alike,’ the article says.

The latest issue of UBS Global Asset Management’s Current Perspectives newsletter can be found online at www.ubs.com/globalam-us.

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