Plan Sponsors Act Defensively in Making Investment Decisions

Institutional investors are not acting fully on their own expectations when making their asset-allocation decisions, research suggests.

Newly published research finds that plan sponsors’ expectations of performance are driven by past performance, investment consultants’ recommendations, and soft factors which they identify in their asset managers, such as having a consistent investment philosophy, clear decisionmaking processes and capable investment professionals.

Researchers Howard Jones, from the Saïd Business School, University of Oxford, and Jose Martinez, from the University of Connecticut School of Business, say the partial dependency of expected performance on past performance and soft factors is not, in itself, irrational. Investors could use such variables as signals of future performance. However, what they did find irrational is that past performance is relied upon when it is uninformative about future performance, and the same was true for soft factors.

According to the researchers, it seems likely that plan sponsors’ actions are at variance with their own expectations because they feel that past performance and consultants’ recommendations are more defensible explanations for their decisions to their the superiors and other stakeholders. “The policy implications of this are sobering. For, as long as sponsors consider that they will be judged by others who do believe that past performance and consultants’ recommendations are informative about future performance, sponsors will behave as if they do so themselves, even if this is not the case,” the research report says.

Jones and Martinez compared surveys conducted by Greenwich Associates between 1999 and 2011, looking into the judgements by plan sponsors of their asset managers with data provided by eVestment about the returns of institutional U.S. equity asset managers, as well as their assets under management for the same period. The analysis was limited to U.S. long-only active equity asset managers.

The researchers suggest that past performance and consultants’ recommendations are widely followed measures because plan sponsors know that, if they fail, they “fail conventionally.” The researchers conclude that their findings support the theory that plan sponsors implement scapegoat strategies and their decisions are affected by career considerations and their interest in deflecting responsibility.

The research report may be downloaded from here.