Morningstar - Q1 2020 - 42

Strategies

more funds. Default acceptance for plans in the
first group (about 10 funds) is 73.6% versus
87.1% for plans in the fifth group (about 30 funds).
Ignoring other potential effects, this suggests
default acceptance increases by approximately
0.7% for each additional fund in the core menu.
Self-Directed Portfolio Analysis
While most participants select the default
investment option when available, there are some
who will still self-direct their accounts. For
this group, it is worth exploring the potential

relation of core menu size and the quality
of their respective portfolios. For this data set,
we only include participants who have
less than 95% of the total balance in a target-date
fund or the plan default. While we primarily
focus on the fund balances for this analysis
(because it is how the participant's account
is invested), we also estimate statistics based on
fund allocations for robustness purposes
and note the same conclusions. A total of 112,572
participants across 504 plans is available for
this analysis.

EXHIBIT 2

Demographic Effect Variables such as age have a notable impact on default
acceptance.
1

2

3

4

Default Acceptance Rate

5

100%

1

2

3

4

75
Default Acceptance Rate

5

100%
50
75
25

# Core
Menu Funds

Age

Deferral Rate

Salary

Balance

0
50
25

Source: Morningstar.

0
#EXHIBIT
Core 3
Age
Deferral Rate
Salary
Balance
Menu
Funds More Efficient Portfolios? Expected risk-adjusted return is highest
Who
Alpha (basis points)
1 Builds
2
3
4 5

for younger investors with lower tenures, higher deferral rates, higher salaries, and8
higher balances.
1

2

3

4

4
Alpha (basis points)

5

80
-44

# Core
Menu Funds
1

2

Age
3

4

Deferral Rate

Salary

Deferral Rate

-4
Number of Investment Categories
-8
10
Salary
Balance

5

# Core
Menu Funds

Age

Balance

-8
0

Source: Morningstar.

1

2

3

4

5

Number of Investment Categories9
10

42

Morningstar Q1 2020

8

The assumed investment style for each fund is its
Morningstar Category. We map each of these
styles to an index that we believe best reflects the
investment exposures of that respective style
for which we have forward-looking capital market
assumptions. Note, we do not perform any
type of further style analysis on the respective
funds. Our approach implicitly assumes the
participant is selecting a fund based on its primary
style exposure. While other attributes of the
individual funds are likely to affect allocation
decisions (for example, past performance), using
a Morningstar Category-mapped index allows
us to use general style weights of the fund without
worrying about the unique tilts implicit within
each portfolio manager's strategy.
Because the expected return is going to differ by
risk level (for example, participants who have
portfolios with higher standard deviations have
higher expected returns up to standard deviations
of approximately 20%), we adjust for risk by
subtracting the average geometric return for each
expected standard deviation. We only include
standard deviations up to 20%, because there are
several portfolios past this point that have
higher levels of risk and lower expected geometric
returns (they are inefficient). Subtracting the
risk-adjusted benchmark geometric return from
the participant-portfolio expected geometric
return results in an alpha metric for each portfolio.
We next center the alphas so that the average
alpha among all self-directed investors
is zero. Again, though, this is still approximately
55 basis points below the expected returns
of allocation funds. EXHIB IT 3 includes
the risk-adjusted expected performance (alpha)
for the various demographic groups and by
plan-menu size.
Portfolio efficiency (expected risk-adjusted
return) is highest for younger investors with lower
tenures, higher deferral rates, higher salaries,
and higher balances; however, the alphas
are not all that economically significant (generally
ranging between positive/negative 5 basis
points). Because portfolio efficiency decreases
by age but increases with other metrics that
are generally associated with sophistication (for
example, income and balance), it likely
warrants additional analysis. There is a clear
Morningstar - Q1 2020

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