Retirement Plan Fiduciary Mistake – Focusing Solely on Past Investment Performance
Fiduciaries are not responsible for delivering the absolute best investment performance. They are responsible for following a prudent decision-making process that is reasonable and well-documented, and for making decisions with the best interest of participants in mind.
Focusing primarily or solely on past investment returns could result in the following fiduciary mistakes:
- Ignoring the fact that past returns do not guarantee future results.
- Overlooking areas such as diversification, asset class, and style shifts (e.g. a growth fund that is invested more like a value fund).
- Not considering how the investment options and structure will benefit your average participant.
- Not giving volatility adequate consideration (short-term returns can be a poor indicator of long-term performance).
- Ignoring the risk/reward tradeoff – some funds do fairly risky things to generate return; is this appropriate for your plan and participants?
- Forgetting about the long-term impact of more expensive funds – in the long run, it is hard for active managers to beat indices after all expenses are considered.
Perhaps the best way to show a prudent process is through documentation. That includes a written Investment Policy Statement and documentation showing the review of investments per the criteria outlined in the IPS. It also includes committee meeting minutes highlighting discussions, questions raised, decisions made and the thought process behind those decisions.
In times of extreme market volatility such as we are experiencing currently, past performance could turn on a dime. It’s not uncommon for non-index funds to perform several percent below their benchmark due to their security selection and sector weightings. We have seen category ranking moves from mid-30’s to mid-70’s within one quarter. Looking solely at past investment returns may lead to premature decisions which could negatively impact a plan’s long-term investment strategy.
With following the IPS guidelines, it becomes a balancing act of patience and not trying to time the market… There may not be a clear line as to how long a mutual fund should be held while falling below criteria listed in the IPS. Your prudent process should include a review of the items mentioned above such as the fund’s diversification and risk level. You should understand what is causing the underperformance; is it the result of a fundamental shift at the fund company or short term shifts in the general equity markets. It’s appropriate to develop a plan which includes monitoring and reviewing alternatives, which may or may not lead to a change in investments.
Bottom line, make sure your prudent process is more robust than just looking at 1, 3, 5, and 10 year performance.