A new research paper by Donald B. Keim, the John B. Neff Professor of Finance at The Wharton School, University of Pennsylvania, and Olivia S. Mitchell, professor of insurance, risk management and business economics with Wharton’s Policy Pension Research Council, takes a deep dive into an interesting case study in which a real retirement plan sponsor fundamentally reworked its investment menu.
Plan officials will by now be familiar with the tenants of streamlining a defined contribution (DC) plan menu—for example, eliminating multiple funds in the same equity asset class or re-enrolling unsophisticated participants into a professionally managed asset-allocation solution. In this particular case the plan menu was reduced considerably, “with almost half of the funds deleted from the lineup.”
This streamlining process was intended to simplify the fund menu, researchers explain, “but it is important to note that the average characteristics of the menu of offered funds (e.g., expense ratio, within-fund turnover, systematic and idiosyncratic risk) were the same before and after the streamlining.”
Even with a similar average risk profile and expense ratios, the paper clearly shows the reformed menu promoted better decisionmaking by retirement plan participants. Specifically, new allocations from participants post-reform exhibited “significantly lower within-fund turnover rates and expense ratios, and we estimate this could lead to aggregate savings for these participants over a 20-year period of $20.2 million, or in excess of $9,400 per participant,” the paper explains.
After the reform, streamlined participants’ portfolios also held “significantly less equity and exhibited significantly lower risks,” mainly due to reduced exposures to systematic risk factors as compared with “non-streamlined counterparts.”
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The researchers also considered how participants contributed to the menu of funds pre-reform and what happened to their fund allocations, along with the costs and risks of the resulting portfolios, as a result of the “firm-wide DC plan streamlining effort.”
Interestingly, the participants who benefitted from this particular example of menu simplification “proved to be older, more likely to be male, and higher-income.” They also initially held higher balances in riskier funds and lower balances in safer balanced or target-date funds.
“Participants holding the deleted funds either reallocated their money to funds kept in the lineup in advance of the deadline to maintain a similar pre- and post-streamlining allocation, or were defaulted into target-date funds (TDFs) resulting in an allocation containing, on average, safer assets,” the report explains. “Only 9% of the streamlined participants elected the new brokerage window (taking only 0.4% of their assets).”
Overall participants adjusted their portfolio holdings fairly substantially, the paper concludes, ending up with “fewer funds, significantly lower within-fund turnover rates, and lower expense ratios … Also, after the reform and relative to the non-streamlined participants, streamlined participants’ portfolios generally exhibited lower diversifiable/idiosyncratic risk and less exposure to systematic/non-diversifiable risk factors.”
The full paper is available for download here.