Morningstar - Q3 2020 - 28

Spotlight: Be Prepared

March. According to Morningstar data, investors
pulled a record amount of $326 billion from
long-term equity and bond mutual funds
and exchange-traded funds in March as they
fled to safety, pouring a record $685 billion
into money market funds. We've come to expect
this type of investment behavior. The
human brain is wired to seek safety when it
perceives danger.
As investors, how can we prepare ourselves
to counter a behavior that in the long run
could be detrimental to our wealth? The answer
might lie in a recent study we conducted.
The first quarter's significant market volatility
provided us with an opportunity to learn
how retirement-plan participants responded to
extreme changes in stock prices.
In this article, we explore the investment
behavior of 617,376 participants across 531
retirement plans between Dec. 31 and
March 31. Our primary focus is on whether
professionally managed portfolios-specifically
the target-date funds and managed
retirement accounts that have become popular
in recent years-insulated participants
from the negative effects of sentiment-driven
trading in retirement accounts. Our
secondary focus is on determining how the other
participants managed their portfolios.
Overall, we found that only 2% of participants
using professionally managed portfolios
made changes to their portfolios. We found that
16.6% of participants self-directing their
accounts made changes. These differences
persisted even after we controlled for
participant demographics.
We also found that participants who opted
into or were defaulted into managed accounts
were less likely to make portfolio changes
than participants who invested in a single
target-date fund. This finding implies that investors
using managed accounts had a higher level
of trust in their portfolio than did investors holding
a single target-date fund. This makes sense,
because managed accounts offer participants
personalized portfolios tailored to each
individual's financial situation.

28

Morningstar Q3 2020

Among participants directing their own portfolio,
the likelihood of making changes appears
to increase with the level of investor sophistication.
Older participants, especially those with higher
equity allocations at the end of 2019, made
the most extreme changes in allocations. This is
noteworthy because the use of professionally
managed portfolios declines with age and account
balance, and it suggests that participants
who might benefit the most from delegating their
investments are the least likely to do so.
Delegated vs. Self-Directed
The data we used in the study come from a single
recordkeeper with a market share outside
of the top 10. We observed participant portfolio
allocations and balances on both Dec. 31 and
March 31, along with characteristics such as age,
salary, plan tenure, gender (when reported),
traditional and Roth employee deferral rates,
and plan participation status. Collectively, these
participants managed $75 billion on Dec. 31
and $65.3 billion on March 31.

We classified participants into five groups based
on their allocations and balances on Dec. 31.
Three of these groups delegated their portfolio
management.
The largest of the delegated groups consisted of
participants who allocated all of their contributions
to a single target-date fund. These "pure
target-date fund" participants do not have
a balance in any other fund. Target-date funds vary
their asset allocation based on the number
of years to a prespecified target retirement year.
The fund's allocation automatically becomes
more conservative as the retirement date nears.
Target-date funds became the most popular default
investment option within 401(k) plans in the
years immediately after the passage of the Pension
Protection Act of 2006. Pure target-date fund
participants account for 43.1% of our participant
sample and 16.3% of plan assets. While it is
likely that the majority of these participants were
defaulted into the funds, this is not something
that the recordkeeper tracks.
The other two groups of delegated participants
invest through (robo-advised) managed retirement
accounts either by choice (by opting into the

managed-account product) or by default.
Managed-account products are a natural evolution
of target-date funds. They provide participants
with portfolios that are personalized based
not only on the expected number of years to
retirement, but also on other aspects of investors'
financial life, such as the amount and composition
of other retirement assets (including Social
Security benefits). Collectively, managed accounts
make up 10.5% of plan participants and 7.7%
of plan assets. Twice as many participants
are defaulted into a managed account than opt
into one.
Taken together, the three groups of delegated
participants account for 53.6% of participants
but only 23% of plan assets-because managed
portfolios and target-date funds are the
most popular with the youngest and newest
participants.
The other two groups of participants manage
their own retirement portfolios, at least
in part. Self-directed participants, who allocate
their contributions to one or more options
that are not target-date funds, account for
39.5% of participants and 68% of plan assets.
They tend to be the oldest participants,
have the highest salaries, and have the longest
plan tenures.
The remaining 6.9% of participants and 9% of
plan assets are classified as "mixed target-date
fund" participants because they combine
allocations to a target-date fund with other funds
available in the core menu.
There are 2,391 distinct investment options across
the 531 plans, of which approximately 70%
are mutual funds. The assumed equity allocations
for each investment are based on the Morningstar
average within its category to ensure any
changes in equity levels are a result of participant
decisions rather than changes made by the
portfolio manager.
Frequency of Changes
In EXHIB IT 1 , we report on our findings for each
of the five groups. The first column is the
percentage of participants who made "any change"
to their portfolios. We then break down what
Morningstar - Q3 2020

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