Individual investors may understand, in theory, that past performance doesn’t predict future results. But they still can’t help moving their retirement money into funds that did well over the last year or two, even though conditions — and investment returns — in the coming year or two may well be different.

Now, research from the Center for Retirement Research at Boston College suggests that employers who administer 401(k) retirement plans — who, ostensibly, should be more sophisticated about such things — have a similar propensity. They tend to drop lower-performing mutual funds from their plans and add better-performing funds, but improved results from the new investments are fleeting.

So, it seems, we should add choosing funds to the list of things that many employers could improve, at least when it comes to managing retirement plans — along with being upfront about fees paid for managing the program, and offering employees a menu of low-cost index funds.

The study, highlighted recently by Investment News, examined 43 plans with an average total balance of $310 million from 1994 to 1999. The researchers analyzed changes the employers made to their menus in that period.

In that time, the employers added 215 mutual funds and dropped 45. (More than half of the new additions were chosen from an investment category that wasn’t already held by the plan.)

The analysis looked at the performance of the added and dropped funds for three years before the change and three years after. Not surprisingly, the report found, added funds had outperformed a group of randomly selected similar funds before the change was made, by 1.34 percentage points each year. Before the dropped funds were dropped, they underperformed a group of random funds by 1.43 percentage points. So overall, the added funds outperformed the dropped funds by 2.77 percentage points annually before the changes were made.

Unfortunately, this performance “bonus” all but disappeared after the fund changes were made, the researchers found. The added funds did worse (they outperformed random funds by just 0.44 percentage point), while the dropped funds did a bit better (they outperformed the random funds by 0.17 percentage point), but the difference between their performances wasn’t statistically significant.

The finding, the authors note, “suggests that plan managers were chasing returns, but their efforts to tinker with their fund selections had essentially no impact on overall performance.” They concluded that “when making changes to a plan’s funds, administrators chase returns and do not end up improving investment performance.”

One of the authors of the research, Martin J. Gruber, professor emeritus at New York University’s Leonard N. Stern School of Business, told Investment News that poor fund choices by employers tend to become magnified by bad choices made by employees. “Participants tend to allocate inefficiently,” he said. “If you give them bad choices, then there is a tendency for them to put more money into those bad choices.”

Have you ever asked  your employer how the funds in your retirement plan are chosen?

Article source: http://bucks.blogs.nytimes.com/2013/01/15/employers-also-chase-mutual-fund-performance/?partner=rss&emc=rss