Global (excluding US) pension fund performance

Pension fund performance describes the performance of pension fund managers, sampled worldwide. Pension funds are the funding mechanism for defined benefit plans, and in some countries are used as funding mechanisms for contributory retirement savings programs.

Comparison to mutual fund structure
The organizational structure of the pension fund industry is distinct from the mutual fund industry. In the mutual fund industry, retail investors directly allocate their own personal wealth to the mutual fund of their choice. In the corporate pension fund industry, the employees of a corporation typically delegate investment choices to a corporate treasurer who then selects a pension fund. This additional layer of delegation offers several benefits. Pooling the assets of many small investors allows treasurers greater negotiating power and monitoring capacity.

In addition, Del Guercio and Tkac (2002) provide evidence that corporate treasurers are more financially sophisticated than the average retail investor. Their greater financial sophistication may allow them to better identify skilled fund managers. However, delegation may also result in agency costs. Rational investors’ desire high risk adjusted returns, but treasurers may have a different objective.

On the other hand Bauer, Frehen, Lum, and Otten (2008), finding pension fund investment performance surpassing mutual fund performance, suggest that the return differential results from higher mutual fund agency costs.

Government employees participate in public defined benefit plans managed by the sponsoring government.

Adonov, Bauer, and Cremers (2013) note that US public government defined pensions (unlike US corporate, Canadian and European defined pensions) are allowed by law to use the investment return rate as the discount rate for liability matching. This has led to both lower funding of pensions and the use of higher risk portfolios. The US public pensions have underperformed their more conservatively run counterparts by 0.60% per annum.

Pension funds have the following additional characteristics:
 * Unlike mutual funds, which are confronted with continual buying and selling of fund shares by individual investors, pension funds have investment flows defined by long term worker contributions and long term actuarial disbursements. The size of the fund is dependent on the size of the worker population the plan covers and the pension promises made to the workers.
 * Pension funds have, on average, lower expense ratios than average mutual fund expense ratios. Pension funds can manage investments internally at lower costs, or delegate investment funds to external managers of institutional funds. Most funds have both internally managed portfolios and externally delegated portfolios.

Descriptive statistics
According to a 2011 study, US defined benefit plans held 6.454 trillion dollars in 2010, representing 43% of US retirement pension plan assets.

The table below provides the mean strategic policy asset class weights for defined benefit plans over the period spanning 1990 - 2010. The asset class breakdown consists of equity, fixed income, cash and alternative assets. Alternative assets include investments in tactical asset allocation, commodities, natural resources, real estate, infrastructure, private equity and hedge funds.

The table below shows mean expense ratios for US defined pension plans over the 1990 - 2010 period. The mean all assets expense ratio rose over the span to an end of period average 0.55% due to an increase in the strategic allocation to alternative asset classes.

Andanov, Bauer, and Cremers (2012) find economy of scale to be advantageous in reducing costs: "...one standard deviation increase in the log of assets reduces the total investment costs by 7 basis points. The scale advantage is much more pronounced for alternative investments, where a one-unit increase in the log of alternative assets results in 111 basis points lower costs. As expected, funds managing a greater percent of their assets through active and external mandates have higher investment costs."

Performance
Unlike the history of US mutual fund performance studies, which is based on a great deal of available performance data, studies on defined benefit pension plan performance and persistence of performance have been hampered by the lack of available data. Most early studies examine the performance of externally managed institutional funds used by pension plans who delegate investment management to an outside fund. Later studies, using data from benchmarks provided by a Canadian based benchmarking firm (CEM Benchmarking Inc.), examine the performance history of defined benefit plans.

Early studies
A survey of early studies follows:

Beebower and Bergstrom (1977)
This study was among the first to investigate the performance of delegated portfolios for defined benefit plans. The study examines 148 portfolios over the 1966 - 1975 period. Using a CAPM framework they found the average portfolio outperformed the S&P 500 index by 1.44% per year along with a pattern of performance persistence.

Brinson, Hood, and Beebower (1986)
The study examines the returns of 91 defined benefit plans during 1974-1983. Benchmarked against the S&P 500, these plans underperformed by 110 basis points per year and showed no evidence of superior security selection or market timing persistence.

Ippolito and Turner (1987)
This study investigates a sample of 1,526 plans during 1977-1983 and finds that the average plan underperformed the S&P 500 in a CAPM framework by 44 basis points per year but outperformed a weighted stock-bond index by approximately 38 basis points.

Lakonishok, Shleifer, and Vishny (1992)
The study examines the performance of 341 investment management firms between 1983 and 1989. They find that the firms underperformed the S&P 500 by 260 basis points per year, and acknowledge that although some evidence of persistence exists, data limitations prevent a robust conclusion.

Coggin, Fabozzi, and Rahman (1993)
This study revisits the Brinson, Hood, and Beebower (1986) study, and documents positive selectivity and negative timing skills for a random sample of 71 equity managers from US pension plans.

Busse, Goyal, and Wahal (2006)
This expansive study examines the performance and persistence in performance of 4,617 active domestic equity institutional products managed by 1,448 investment management firms between 1991 and 2008. Controlling for the Fama–French (1993) three factors and momentum, aggregate and average estimates of alphas are statistically indistinguishable from zero. They find only modest evidence of persistence in three-factor models and little to none in four-factor models.

Studies using the CEM database
The CEM database allows academics to study the performance metrics of individual defined benefit plans.

Andonov, Bauer, and Cremers (2012)
The study examines defined benefit plan performance over the 1990–2010 period. The CEM database includes a total of 557 U.S. pension funds which account for approximately 30-40% of the asset under management by U.S. pension funds. In 2010, the holdings in U.S. equity of U.S. pension funds included in the CEM universe represent 4.2% of the market capitalization of the NYSE, NASDAQ and AMEX and their fixed income holdings are equal to about 2% of the total outstanding U.S. bond market debt.

The study measures plan performance in terms of asset allocation policy, market timing, and security selection. Over the 1990 - 2010 period, the average pension plan provided an annual excess return of 89 basis points after risk adjusting for equity, market, size, value, liquidity, and fixed income market factors. The distribution of excess return breaks down as follows:


 * Asset allocation. The average plan produced 25 basis points of excess annual return by setting asset allocation. Most of this excess return is attributable to an increase in alternative asset class allocation over the period. Plans also increased allocations to international stocks over the period.
 *  Market timing. The average plan reaped 26 basis points of excess return due to passive exposure to time-series momentum.
 * Security selection. The average plan received 25 basis points of excess return from security selection. However, this return becomes insignificant after controlling for risk factors and is attributable to the momentum in equity markets.

The study finds that large plans, while having lower costs than smaller plans face size liquidity restrictions as well as potential organizational issues that reduce returns.