How Long Is Long Enough?

Abstract

Defined-contribution plan (DCP) fiduciaries are often faced with conflicting perspectives when executing their responsibilities and terminating underperforming active managers are involved. Consultants, investment managers, and capital market intermediaries generally argue that more time is needed to prove that an investment strategy is suboptimal. These parties often have inherent conflicts of interest to argue for active management over passive management. Most conflicts are economic in nature, but some are steeped in intellectual hubris. In this article, the authors enter the fray from the plan participant (PP) side. Ultimately, the very essence of a DCP is to offer a menu of investment options that enable PPs to optimize wealth aggregation in a diversified manner using a multiasset class solution. We show that PPs are better served when fiduciaries monitor active investment managers and replace them with passive alternatives in a timely manner if they underperform. Too often plan fiduciaries churn a DCP by replacing underperforming active funds with other active funds.

TOPICS: Manager selection, mutual fund performance, passive strategies, retirement, wealth management

Key Findings

• • Defined-contribution plan participants are better served when fiduciaries monitor active investment managers and replace them with passive alternatives in a timely manner if they underperform.

• • A three-year rolling return window to compare active fund returns with benchmark returns seems to provide the best decision criterion for the active-to-passive decision.

• • Plan participants are far better served by fiduciaries who have a well-structured, discrete decision framework for replacing underperforming active funds.