What’s in a name?

next issue no. 7: Participant engagement

Challenge

Helping plan sponsors avoid the common tendency and pitfall of naturally gravitating toward the easier, more common brand name options based on false, preconceived notions.

Opportunity

Consider a “white label” approach during the investment selection and/or review process within the qualified default investment alternative (QDIA) category.

Benefits

Consider a “white label” approach during the investment selection and/or review process within the qualified default investment alternative (QDIA) category.

• Process can be a valuable differentiator.
• Provides fact based solutions, which eliminates emotional choices.
• Avoids certain behavioral finance missteps.
• Provides an unbiased, fiduciary approach to investment selection.
• Best of breed options clearly analyzed regardless of branding or preconceived notions.
• Plan sponsor grasps the importance of the investment due diligence process.
• Plan consultant able to demonstrate/ highlight the value of their role as it pertains to true, unbiased investment due diligence.

What is bias?

Inherent biases are all around us, whether subconscious or more overt. The schools of thought around cognitive bias have grown massively of late, and how the field of study can be applied to corporate activities has become a hot topic. The field of behavioral financial theory is the directed study of psychological influences on investors and financial analysis. Broadly evolving from the underlying study that investors are not always perfectly rational, the field examines how investors can act against their self-interest, and can fail to objectively examine potentially more appropriate investment options.

More specifically, different types of group-think, loss aversion, and overconfidence all feed into types of bias that can impede a plan sponsor’s ability to identify the best investment options for participants. In this article we will examine a number of key bias types that can have an impact on collective decisions. We will examine how they may apply to plan sponsors and why we may want to work to combat these biases.

These four principles are, in essence, embedded in human nature, but a basic awareness of how our brains can conspire against our interest in making purely rational choices can have profound consequences when it comes to examining potential investment options.

Plan sponsor committee meetings

Within the context of plan sponsors’ planning options there are several more sets of biases to bear in mind, many of which are most potent within a group setting where communication might be challenged and time pressures may amplify errors.

Confirmation bias is the way that the human brain generally dislikes information that disagrees with preformed notions. New information that is presented is interpreted as reinforcing the decision that has already subconsciously been made. Within the context of plan sponsors this is especially relevant when given information regarding different fund options; the brain has already decided on a recognized brand of asset manager, or the fund with simply the lowest fees, and information that is gathered simply reinforces that decision, rather than challenges it. This poses particular difficulties in organizations where there is a hierarchy, as it can be tough to challenge senior leadership and push for new data to be interpreted in a way that pushes against preconceived decisions.

The sunk cost fallacy is common in investing more broadly, where costs, time and effort already put into a decision or investment count against conceding that the decision was incorrect. This is particularly relevant to plan sponsors when it comes to changing options, as the time, due diligence and overall effort put into adding funds to platforms means that even if those funds are underperforming or no longer the best options available, it can be difficult to change course.

Herd mentality, the tendency for groups of people to think as a single group, rather than as a collective of individuals, is relevant in investing and fund selection due to the pressures of operating as a Board or a Trust. Maintaining independence and the confidence to push back against the group is vital to overcoming this bias.

Applying this knowledge

The key is understanding the potential impact on plan sponsors and where these underlying biases can have a profound impact on decision-making. To apply this theory to plan sponsors and choices of funds that should be available for participants, we began to incorporate a “white label” approach in our finals scenarios. We encouraged breaking away from simply looking at the lowest fees, or funds that came from the best-known brands, or those that had sat in the top decile of performance for the most recent timeframe. Each of these elements may be erroneously utilized to justify investment decisions. We believe that incorporating a more holistic approach to fund selection is a more prudent process when building or adjusting a plan lineup.

It is critical to have a plan sponsor recognize that just because a fund option has been around the longest and/or has the lowest listed fees does not necessarily mean that it should be considered as the default option. That position, “if it’s been around the longest it must be the best” or “it is cheapest therefore we should choose it,”, lends itself very easily to many of the bias characteristics outlined above. Deeper analysis, double-blind viewing of investment options and breaking away from group-think can ultimately lead to better options being considered and potentially chosen.

The consultants that approach analyzing investment options in an unbiased blind manner can be a valuable differentiator. That the selection of investments is un-incentivized for the consultant and is a demonstrably non-biased approach, can have a range of valuable consequences. Having these conversations and having a plan sponsor buy into that approach can again allow broader options to be considered outside of those with the easiest brand recognition or lowest fees.

In the following anonymized-but-genuine example in Figure 6 we compare two large index target date providers. Company B has arguably a more recognizable name brand. However, when looking at the double-blind example, our focus is off the brand names and is more appropriately directed towards the more important aspect of performance. While Company A has a lesser known name, it has consistently outperformed Company B in every listed timeframe.

How do we approach these issues in an unbiased manner?

Remove the brand name and emphasize the facts.

• This process truly aids in the ability of the consultant and the plan sponsor to be on the same page when analyzing the investment lineup through the lens of a fiduciary.
• The result should be a first in class, well-vetted lineup determined by analyzing the most critical data points, rather than the brand. Thus ultimately providing the best solution for the retirement plan and its participants.

Summary

Analyzing investments using a white label approach allows us to discern the more important factors for the plan sponsor. Performance, fees and risk-adjusted measures are all considered.