'Set It and Forget It' Plan Design Could Harm 401(k) Investors

“Plan sponsors, whether they use an outside fiduciary advisor or rely on internal investment committees, are being diligent in their monitoring,” said Licato of the new research. “You need to stay on top of your menu design, and make changes when necessary.”

Replacement equity funds had the highest rate of outperformance, but each of the three broad asset classes Morningstar reviewed outperformed the replaced funds. For all three fund groups, the median outperformance was 22 basis points after one year, 26 basis points after two years, and 52 basis points after three years.

What explains the outperformance?

Morningstar’s analysis establishes a correlation between replacement funds’ historical performance and their ability to outperform going forward, and underscores how lower-fee funds can contribute to better performance.

But the full explanation of why replacement funds do better going forward remains “elusive,” according to the report. Licato said Morningstar intends to conduct further analysis on more complete data.

Nevertheless, the research underscores the value of plan monitoring, and perhaps even the value third-party fiduciary advisors can bring to plans.

“If you don’t have strong monitoring, that opens up potential problems,” said Licato. “If you simply set it and forget it, you’re doing a disservice for the investor.”

Morningstar offers 3(21) and 3(38) fiduciary advisory services to 401(k) plan sponsors, along with its managed account platform, which touts a capability to design personalized investment strategies within a plan sponsor’s core investment offering.

Though still in its nascent stage, Licato thinks Morningstar’s new research proves the value of plan monitoring, irrespective of the firm’s business interest in facilitating plan sponsors’ legal obligations.

“Whether you are working with Morningstar, another fiduciary advisor, or your own investment committee, a sponsor needs people staying on top of their investment lineup,” he said.

While historical performance can and often does translate to improved future performance, other investment features, like management tenure and turnover, and style drift, need equal consideration.

And monitoring a plan can always prove a menu’s design is right where it needs to be.

“It all comes down to the funds being offered,” said Licato. “If a plan is working with representation from well-established asset managers, and there aren’t any red flags, then there’s not necessarily a need to replace funds.”