NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

How "Sticky" are Investments in Defined Contribution Pension Plans?

...[defined contribution] DC money is more volatile and exhibits more flow-performance sensitivity than non-DC money invested at mutual funds.

Mutual fund holdings in employer-sponsored defined contribution (DC) plans are an important and growing segment of today's financial markets. Assets in DC plans increased from $1.7 trillion in 1995 to $5.1 trillion in 2012, and at the end of this period DC plans constituted 22 percent of total U.S. mutual fund assets and 27 percent of U.S. equity fund assets. Such holdings are expected to remain significant because of the increasing number of Americans moving toward retirement and the transition of corporations and public entities toward the use of defined contribution plans rather than defined benefit plans.

In Defined Contribution Pension Plans: Sticky or Discerning Money? (NBER Working Paper No. 19569), Clemens Sialm, Laura Starks, and Hanjiang Zhang analyze the behavior of plan sponsors and participants. They explore whether DC pension plan investments constitute a source of "sticky" money for mutual funds, in the sense that once contributions flow into a given fund they are very unlikely to be redirected to another fund.

The authors observe that DC plan fund flows are driven both by the menu choices offered by plan sponsors and by the decisions of individual plan participants. Contrary to the widely held belief that DC plan assets are sticky because of plan participants' inertia, the authors report that the DC money is more volatile and exhibits more flow-performance sensitivity than non-DC money invested at mutual funds. There is less autocorrelation from one year to the next in where DC funds are invested than in non-DC investments. Using a sample of plan sponsor data, the authors find that this flow-performance sensitivity is driven by the actions of plan sponsors in dropping poorly performing funds from their menus and adding well-performing funds. This process of changing the menu of investment choices for plan participants has the effect of moving participants' assets, even if the participants initiate relatively few transactions on their own. The differences in flow patterns between DC and non-DC investors that the authors document suggest that mutual fund management companies can diversify the net flows into their funds by offering the funds to both DC and non-DC investors.

The authors also examine whether DC plan sponsors and their participants are more discerning in fund selections than non-DC investors, in the sense that such flows can predict funds' long-term future return performance. While non-DC fund flows predict future performance negatively, the authors find that DC fund flows have no predictive power for future fund returns. They conclude that plan sponsors prevent their participants, on average, from pursuing whatever investment strategies lead non-DC investors to negatively predict future fund performance.

--Les Picker

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