If most defined contribution pension plan members who invest their own money underperform those who invest through professionally managed options, how can plan sponsors encourage more uptake of default options?
“By understanding the drivers associated with acceptance of a default investment, plan sponsors and defined contribution plan consultants might have additional success getting more participants into professionally managed investment options with the ability to predict which default investment will be most accepted,” said a new working paper by Morningstar Investment Management.
Read: OSFI publishes guidance on default investment options in DC pension plans
Past research has found plan members are more likely to accept default options if they’re younger with lower deferral rates, salaries and balances and if the default is a managed account rather than a target-date fund or a balanced fund, noted the paper.
Morningstar looked to expand this understanding, particularly focusing on target-date funds, by reviewing the default investment decisions of 46,439 members across 175 DC plans using 18 different target-date series. Of note, the research specifically considered members who are new to their plans with tenures of less than three years.
In particular, it explored the default investment’s expense ratio, the size of the sponsoring target-date fund company, the relative risk or the target-date vintage and the relative performance of the fund.
The research found the target-date attributes don’t matter as much to default acceptance as certain demographic variables like income and account balance.
Read: More pension plans using target-date funds as default option
However, it also found an increased default acceptance for target-date funds with lower expense ratios, lower levels of equity risk and higher relative performance. “The expense ratio relations is notable because it suggests funds with higher expense ratios not only have a higher level of expenses to overcome to generate alpha, but they also may result in lower levels of default investment usage,” the paper said.
Overall, the research demonstrated that while demographic attributes seem to be the top reason that plan members accept default funds, the investment attributes also have an impact.
“While far from perfect, target-date funds are professionally managed multi-asset portfolios that are likely to result in better investment outcomes than in a participant was to self-direct his or her own portfolio. Therefore, the goal should be to get as many participants in the default investment as possible, and to keep them there.”