U.S. workers are helping support and sustain the stock market rally through their defined contribution pension plans.
Experts say these employees also helped the market shrug off temporary setbacks, such as the Dow Jones industrial average's 57.41 point drop July 19.
These defined contribution plan participants so far have been steady and patient investors in stock mutual funds. What's unknown, however, is whether they will flee the stock market in the event of a sharp correction.
Because participant-directed plans are so new, no one knows what effect that flight would have on an already battered stock market.
And that's troubling.
No hard data exist on "the 401(k) effect." But three research projects under way could shed some light on how participant-directed investments affect markets.
Birinyi Associates, Greenwich, Conn., is looking at the effect of defined contribution flows on various investments from stocks to money market funds. Access Research, Windsor, Conn., is working on an overview of individual retirement accounts and defined contribution rollovers into mutual funds. It will be completed by year end. And, the Investment Co. Institute, the mutual fund industry trade group, soon will release its annual pension statistics.
Many investment professionals believe the impact is profound.
"There's no question in my mind that (defined contribution participants) are serving to bolster the market above and beyond what it would normally be valued at. That's the way cash flows work," said Peter Anderson, senior vice president for investment of American Express Financial Advisors Inc., Minneapolis.
"Over the last five years (the boom in defined contribution plan assets) has caused the market to move higher and for longer."
Mr. Anderson said the test of investor steadfastness will be a sharp, 10% to 15% correction followed by a monotonous yearlong flat market.
Will investors flee, or stay
If that happens, he predicts investors will flee stocks for less aggressive mutual funds.
But other observers disagree. They think plan participants will stay put.
There's a lot of money at stake. Defined contribution plans among the nation's largest 1,000 employee benefit funds, as measured by Pensions & Investments, have $657 billion in assets. The 200 largest funds had 25.2% of their assets, or $114.4 billion, in company stock, and 23.6%, or $107.1 billion, in other equities.
Mutual funds attracted $26 billion from defined contribution plans in 1994, the majority in stock funds, according to Strategic Insight, a mutual fund research firm in New York. That's more than $2 billion per month in net sales (sales less redemptions).
"If the majority is equity-related, which it probably is, it becomes a major source - 25% - of equity cash flows or net sales. Clearly it's an important source of stability to the flow of equity investments," said Avi Nachmany, analyst.
Participant-directed investments are a significant source of stock market stability, he said. "Probably 55% of all domestic equity assets are held in retirement-designated tax advantaged accounts. More than half of the equity (fund) business is dependent on the growth and stability of this investment. It really creates a floor for the whole equity mutual fund business," Mr. Nachmany said.
Flows stabilize market
The experience of Pioneer Group, primarily an equity manager, affirms Strategic Insight's findings.
"In the first six months, half of our cash inflows were from retirement plans. It has a stabilizing effect on the market. These are very disciplined investments, not emotional investments. Every month the money keeps coming out of people's paychecks," said Marcy Supovitz, vice president-retirement plans of Pioneer Group, Boston, which runs $12.5 billion.
Said Kathy Rabon, director of industry studies at the ICI in Washington: "More money is going into retirement funds - particularly defined contribution plans - and more of that participant-directed money is going into equities than ever. Those factors are all snowballing to fuel the market."
James Solloway, director of research of Argus Research Corp., New York, said defined contribution flows is one of several factors driving the stock market. Others are a strong economy, declining interest rates and a stock market that is valued appropriately.
American Express' Mr. Anderson warned the ability of participants to switch from one options to another could backfire.
"If the market gets into significant trouble, you might see a shift from growth funds to money market or short-term debt funds - from more aggressive to less aggressive investments. That puts considerable pressure on the market. That's not what's occurred to date, but we haven't had a down market" since 401(k) plans were developed, Mr. Anderson said.
He does not think education efforts will stop participants from pulling out of stock funds. "People chase success. That's what leads to the undoing of most investors. We've had a bull market since 1972. People made money being aggressive. If we go into a major market correction, people might rethink it even though they've been taught otherwise. .*.*. We'll see."
No time bomb
But C. Frazier Evans, senior vice president of Colonial Investment Services Inc., Boston, is less concerned about the 401(k) effect in a down market.
"The money that goes into these plans typically is quite stable. People tend to buy a cluster of mutual funds to achieve some diversification and hold that diversification regardless of market fluctuations. I don't think you have a ticking time bomb here."
Strategic Insight's Mr. Nachmany agreed. "It's somewhat paradoxical. Investors say the market went down in 1987, 1990 and 1994, and they were great buying opportunities. Even if it goes down 1,000 points they'll say 'let's buy.' You would need a lengthy down market to shatter people's confidence, and no one anticipates that."
Besides, said Ms. Rabon, "retirement flows (from IRAs and defined contribution plans) will cushion (the mutual fund industry against) any downturns, if not the whole stock market."
Mary Rudie Barneby, president of Regis Retirement Plan Services, New York, believes participants "generally leave their allocations alone." As a result, she doesn't expect any retreat from stocks "even in very volatile markets."
"People tend to be creatures of habit," she noted.
Some think the 401(k) effect, even on a bull market, may be exaggerated. They're waiting for hard data before drawing conclusions.
John Brennan, president of the Vanguard Group of Investment Cos., Valley Forge, Pa., said: "I'm not sure it's provable one way or the other .*.*."
The positive effect is "one of the things people have been assuming. We think it has a lot to do with (the bull phase). We want to quantify it in excruciating detail," said Laszlo Birinyi, president of Birinyi Associates.
A participant doesn't "understand other investments. He isn't really that enamored with bonds; he's been burned in international; commodities are not a good idea since he's seen what's happened to gold. Equity is the only game left," Mr. Birinyi said.
Colonial's Mr. Evans said he doubts flows into stock funds from defined contribution plans are large enough to prop up the stock market.