A new analysis by PGIM looks at how participants responded, particularly considering the significant structural changes in the DC space since the last major market shock in 2008.
More specifically, the firm set out to understand both the impact of professionally managed portfolios and in-plan guaranteed retirement income options on participant investment behaviors during 2020. The corresponding results were published in the firm’s Stay the Course white paper.
One of the big differences between the two periods, of course, was that in 2008 there was relatively little usage of default investments and annuities.
As one might recall, participants were nervous during 2020, which resulted in increased trading activity, especially when market volatility increased. As such, investors tend to react to downturns and market volatility by moving to more conservative portfolios.
But according to PGIM’s analysis, access and usage of professionally managed portfolios were found to reduce trading activity among DC participants. In view of that, the firm suggests that products and strategies that can keep participants invested during periods of market turmoil can be especially valuable as they effectively “protect participants from themselves.”
Data for the analysis was obtained from Prudential Financial for both 401(k) plans and 403(b) plans. To be included, the plan had to offer Prudential IncomeFlex to participants as of Dec. 31, 2019, which limited the initial test dataset to 730,533 participants. The firm looked at four potential investment-type groups for participants: self-directors (SD); those who were defaulted into a professionally managed multi-fund portfolio (MFP); those who were defaulted into a target-date fund (TDF); and those who opted into a professionally managed multi-fund portfolio (MFP).
Self-Directed vs. Professionally Managed
Overall, approximately 12.8% of all participants self-directing made a change, versus 5.5% for MFP opt-in, 5.5% TDF defaulted, and 4.2% MFP defaulted. Not surprisingly, there were sizeable gaps in portfolio change/trading activity among participants who were self-directing their portfolios and the three professionally managed investment strategies, which had relatively similar change rates, PGIM notes. “We find that participants using any type of professionally managed portfolio solution were significantly less likely to trade in 2020 than those who were self-directing,” the firm says.
Among participants who were self-directing their accounts who traded in 2020, older participants made the most significant changes and seemed to make the worst decisions (i.e., selling out of equities). “These participants were also significantly less likely to use a professionally managed portfolio option, which suggests those participants who may benefit most from professional investment management are not the ones receiving it,” the analysis states.
Yet, while older investors were more likely to make a change, the study’s regression results suggest it’s not age that is the primary driver of the change—a point that is important for plan sponsors and consultants interested in isolating certain groups who may be more likely to transact, the study emphasizes. In fact, those with longer tenure, higher balances, males, higher equity allocations and participants in 401(k) plans were also more likely to make a change, while the probability was lower for females and single individuals.
Behavioral Benefits
Evidence from the analysis also suggests that all default investment structures were effective, but there could be an added behavioral benefit associated with displaying a portfolio as a multi-fund option versus a single fund structure (i.e., a target-date mutual fund), the firm notes.
In this case, participants defaulted in a multi-fund professionally managed portfolio traded less than those who were defaulted in a single fund professionally managed strategy. “While the exact reason for this effect is unclear, a potential explanation could be that the diversification benefits of the multi-fund strategy are more apparent than a single multi-asset fund strategy,” PGIM observes.
For instance, in a multi-fund strategy, the participant would log in and see a diversified, eight-plus fund portfolio versus holding a single TDF, which would appear to be more like a “black box,” the paper explains.
Lifetime Income
There also appears to be some benefit for participants who allocated to an annuity that provides guaranteed lifetime income. Here, the analysis found that the probability of making a change decreases as the guaranteed lifetime income product allocation increases. This was particularly true for older participants (age 55-70) who had higher allocations, as they were found to be less likely to trade during 2020.
“In other words, the more a participant had in a product that provided guaranteed lifetime income the less likely he or she was to trade during 2020; however, participants with smaller allocations (less than 30%) had change rates that we’re higher than those without any product allocation,” the analysis states.
According to PGIM, this suggests guaranteed (or protected) income products have the potential to not only simplify the retirement income decision process, but may also improve participant trading behaviors.
The firm notes that it will continue its research into the levels at which these options offer a significant improvement to participant behavior.
