Should company stock be an optional self-directed investment for parti

[Dave Baker]

A Morningstar employee has written an article that criticizes the practice:

http://www.benefitslink.com/links/20000714...14-006190.shtml

Do you agree?

[Kirk Maldonado]

I see no policy justification for excluding employer stock as an optional investment.

If employees are concerned that they may feel pressured to invest in employer stock, the fiduciaries of the plan should undertake adequate procedures to protect the confidentiality of the manner in which participant account balances are invested.

I would be remiss, though, if I did not point that that there are securities laws (both federal and state) of allowing participants to elect to invest in employer stock. Too often, these securites laws issues are completely missed.

[pjkoehler]

There is a lot of literature recently published in economics and personal finance journals that is of the view that investing an employee's retirement assets in company stock too often results in suboptimal diversification of the employee's total portfolio, especially if he/she already holds stock or stock options outside the plan. I don't think you'd have much trouble finding some aritcles on the IFEBP web site.

[Kirk Maldonado]

PJK:

Are you advocating the position that because some people might overinvest in employer stock, it shouldn't be allowed as an option, or are you merely objectively mentioning those articles (without taking a position)?

[pjkoehler]

Kirk, while reasonable people can disagree, I think on just an empirical level, a strong case can be made that employees who participate in self-directed 401(k) plans that permit investment in employer stock tend to make less rational decisions about taking long positions in that security. They tend to buy it without regard to any rational asset allocation strategy causing their portfolios to have a higher beta coefficient for the level of its return. For sophisticated investors, I doubt this is much of an issue, but self-directed 401(k) plans are, as we know, in general not well managed. Since they are increasingly the delivery vehicle of retirement benefits in the private pension system for low and middle income workers, I think the public policy issue is unavoidable. The present value of a worker's future earnings is already exposed to a substantial unemployment risk which is tied directly to his employer's economic fortunes. Holding employer securities in the worker's 401(k) account further increases his exposure to this risk and frequently results in suboptimal risk-adjusted rate of return. If the worker also holds shares outside the plan or stock options, he's almost certainly over-weighted in that security. Think of the unions who frequently want the trustees of multiemployer plans to invest in projects that boost the employment prospects of its membership or make other economically-targeted investments. In general, these strategies inevitably involve a tradeoff between portfolio performance and nonretirement objectives.

[Edited by PJK on 07-17-2000 at 04:49 PM]

[Guest hank]

Good thread so far.

PJK's mention of recent studies is consistent with what I've seen in the last two-three months, including a recent investor newsletter from Fidelity cautioning participants in self-directed k plans to watch their asset allocation when employer stock is both offered as an investment AND is used for KSOP matching purposes.

I'm a firm believer that employer stock should be offered as an investment option in a self-directed k plan, so long as the plan's fiduciaries have faithfully exercised their roles in determining that the option should be available. Interstingly, our experience is that participants don't dump a lot of their own cash into our stock under the k plan, but allocate their dollars among 10 other options which cover the risk spectrum. Our matching contribution is made entirely in our stock, and participants may begin to diversify that account when they reach age 50.

Our data also show that our participants don't move their k money around very much and there is some data to support the conclusion that those who do have a generally higher level of education than those who do not. We spend a lot of time on participant investment education, but we're not seeing the results.

For what it's worth!

[pjkoehler]

Morningstar has an online 401(k) plan investment advisory services I believe. I know FinancialEngines provides a probability forecast tied to beta based on the mix of mutual fund investments in the account. I don't know if either service provides an analysis of the impact of individual publicly traded stock, but it would be interesting to see if their forecasting models track individual publicly traded securities, as well as mutual fund shares. If they do, then it would be helpful to participants to model their employer stock allocations to determine whether or not they are being compensated for the additional risk, or, conversely, whether they can achieve an allocation including employer stock the provides comparable probability of achieving specified returns for a given level of risk.

[Kirk Maldonado]

It seems to me that a lot of the people so opposed to investments in employer stock have a serious conflict of interest. That is, they either sell investments or investment advice. Both of which are inconsistent with investments in employer stock.

I'm not arguing that participants should invest in employer stock; I'm just opposed to the condescending idea that we know what is best for you, and we are going to force those ideas upon you. I'm sure that there are a number of Microsoft employees that are glad that they invested in employer stock. Of course, other employers' stock prices have not done as well. But the bottom line is that the participant should be entitled to make the decision.

[pjkoehler]

Kirk:

I don't think the conflict-of-interest argument is very persuasive. Don't you think the employer/issuer of the security has a whopper of a conflict in offering shares to its employees, who at best have only limited voting rights and who probably don't vote their shares anyway. It's a great way for management to insulate themselves (i.e. protect their jobs) from the oversight of shareholders whose only focus is on shareholder value.

It really comes down to applying the principles of modern portfolio theory at the participant level, which are not biased one way or the other, about employer securities. Now you can argue that the evaluation of these principles is beyond the ability of most small investors and, therefore, they are subject to manipulation. I've heard of no evidence to support such an allegation. FinancialEngines, for example, was formed and operated by a Nobel laureate in economincs from Stanford Univ. (Bill Sharp). The focus of these firms is not on the particular securities the investor selects, but on measuring the risk-adjusted total portfolio rate of return, so s/he can make better informed decisions.

[Guest hank]

After reading Rekenthaler's piece again, it's hard for me to discern whether he's simply anti-employer stock as a matter of principle or whether he's arguing the obvious: loading up on employer stock in a k plan means the participant is failing the opportunity to spread risk.

Most of what he writes goes to the latter point, I think. But we are left to ponder this Rekenthalerism: linking "human capital to investment capital" is economically "as bad an idea as one can conceive". I'd have to say that he's considerably off the mark on that "wisdom".

Is the lesson that employer stock is OK but, like so many things, only in moderation?

Back to you folks in the west!

[Guest]

As a former financial advisor, I have seen first hand where placing all the employer matching contribution in employer stock was ultimately to the deteriment of the employee. I provided consulting for a retiree that watched his retirement account be cut in half because of the amount of money that was invested in his employer's stock. As a result, this person was forced to seek part-time employment (age 65+) so they could make ends meet.

I am a proponent of employer stock being available for investment in plans, but I think sound investment advice dictates that you limit your exposure to any one company, just as you would if you were investing in stocks inside a self-directed brokerage account. So, limiting the stock to no more than 10% of a participant's portolio is more prudent that placing all matching contributions in the employer's stock.

[Guest Frank]

I found this thread as I am researching the way plan providers provide guidance to a sponsor (as well as indemnify themselves) relative to the 404© requirement to use an independent fuduciary when offerring company stock as an investment vehicle in a plan. As reporting in practice seems to indicate, providers are providing to sponsors information deemed as confidential, i.e. valuation reports, Particpant statments, etc.

Can any of you provide insights, direction, etc. from your experinces on this matter? Thanks. Frank.