Investor Inattention: A Hidden Cost of Choice in Pension Plans?

Published date01 January 2015
Date01 January 2015
Investor Inattention: A Hidden Cost of
Choice in Pension Plans?
Magnus Dahlquist
Stockholm School of Economics, SIFR and Center for Economic Policy Research (CEPR)
José Vicente Martinez
Saïd Business School, University of Oxford and the OxfordMan Institute of Quantitative Finance
We investigate inattention on the part of pension plan participants using a dataset
covering savings in Swedens Premium Pension System. These data permit direct
comparison of the investment behaviours of pension and retail mutual fund
investors. Unlike retail mutual fund investors, pension investors do not seem to
react to past fund performance. This behaviour means that pension investors face a
greater risk of being caught in poorly performing funds. Our evidence suggests that
inertia and inattention to past performance may translate into poorer investment
results for pension investors. We discuss a potential change in the design of dened
contribution pension schemes that may mitigate costs for inattentive investors while
maintaining exibility for attentive investors.
Keywords: ows, inertia, pension plan design, performance, redemptions
JEL classification: G11, G23, H55
1. Introduction
Over the past few decades there has been a gradual shift in pension plans from dened
benettodened contribution. Sweden was an early mover in this trend, implementing
pension reforms in 1998 that introduced a second tier of mandatory individual accounts,
We are grateful to Finansinspektionen, Fondbolagens Förening, the Pension Authority, and
Svensk Fondstatistik for providing us with data, and to NASDAQ OMX and NETSPAR for
financial support. We have benefited from helpful correspondence and discussions with
Alexander Kerl, Joshua Rauh, Marno Verbeek, Martin Weber, an anonymous referee, and
seminar participants at the Stockholm School of Economics, the Institute for Financial
Research (SIFR), University of Oxford, University of Zurich, and NETSPARs international
pension workshop in Zurich.
European Financial Management, Vol. 21, No. 1, 2015, 119
doi: 10.1111/j.1468-036X.2013.12008.x
© 2013 John Wiley & Sons Ltd
the Premium Pension System (PPS). Like most dened contribution schemes, where
investment decisions are made by plan participants, the PPS has many attractive features,
such as exibility and transparency. However, it undoubtedly requires greater individual
responsibility, which, according to recent evidence on investor inattention, individuals
may not be ready or willing to take.
Investor inertia and inattentiveness are welldocumented phenomena in pension plans
(see Samuelson and Zeckhauser, 1998; Madrian and Shea, 2001; Agnew et al., 2003;
Ameriks and Zeldes, 2004; Mitchell et al., 2006). In this study we assess the inertia and
inattention of pension investors and its welfare consequences. We do this by evaluating
the owperformance relationship and investment performance of pension investors
versus retail mutual fund investors on the same set of funds.
We rst investigate whether pension investors are particularly inattentive by comparing
their investment behaviour with that of retail mutual fund investors. If past performance
contains relevant information about managersskill or future performance, sensitivity to
past performance should be a good indicator of attention. The existing literature suggests
that ows into and out of mutual funds are strongly related to measures of past
performance, and that mutual fund investors seem to chase performance (see Chevalier
and Ellison, 1997; Sirri and Tufano, 1998). We nd similar evidence among retail mutual
fund investors in our sample. However, we nd that pension investorsows are
insensitive to past performance. We view this as further evidence of inattention on the part
of pension investors. We also nd strong evidence of investor inertia when new money
enters the PPS. We think there are two reasons why pension investors (or investors
managing their pension accounts) may be more inattentive than mutual fund investors.
First, in a mandatory pension system, pension investors include individuals who may have
no interest in saving or investing for retirement but are legally obliged to do so. Mutual
fund investors, on the other hand, are essentially a selfselected subset of the pension
population that includes only those individuals actually interested in being investors. It
seems natural to expect pension investors to be, on average, less enthusiastic and involved
in managing their accounts, and therefore less responsive to performance, than mutual
fund investors.
Second, even those individuals who hold both a pension and a mutual
fund account could be more attentive to their mutual fund account than to their pension
fund account. The reason for this is that individuals may not care as much about their
lockedin savings or discount them excessively.
We then investigate how investor inertia and inattention affect performance. On the one
hand, models of rational behaviour suggest that investors with superior information/skills
or facing lower transaction costs should be able to perform better than other investors. For
instance, in the model of Berk and Green (2004), where high performance signals a
managers superior ability, investors chase performance and make rational use of
information about fund history in doing so. Money ows into and out of funds to the point
at which no abnormal returns are expected. This implies that, if a group of investors do not
respond to past performance, poorly performing funds can survive without experiencing
Here and throughout the paper we use the term inattentionin a broad sense, to denote lack
of attention, indifference, negligence and even procrastination.
On a similar note, Bilias et al. (2010) present evidence that suggests that households with a
brokerage account are much more likely to trade stocks than those who do not have an
© 2013 John Wiley & Sons Ltd
2Magnus Dahlquist and José Vicente Martinez

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