Table C.1: Regression results: performance and characteristics 1990-2007
We estimate Fama and MacBeth (1973) regressions on the net benchmark-adjusted returns and correct for autocorrelation and heteroscedasticity using Newey-West with three lags. The net benchmark- adjusted returns are constructed after deducting the costs and self-declared benchmark returns from pension fund real estate returns. In Panel A, the dependent variable is the net benchmark-adjusted return on all real estate assets of all pension funds. In Panel B, the dependent variable is the net benchmark-adjusted return on REITs or direct real estate. In Panel C, the dependent variable is the net benchmark-adjusted return on all assets managed internally, externally or via fund-of-funds. We include the following characteristics: Mandate - log of total holdings in real estate (Panel A), log of holdings in one subcategory (Panel B) or log of holdings in one investment approach (Panel C), Costs - total costs for investing in real estate, subcategory of real estate or investment approach, %Ext - per- centage of investments in external mandates, %Act - percentage in active mandates, %FoF - percentage in fund-of-funds, and %LP - percentage in limited partnerships. We report standard errors in brackets and significance levels with *, ** and ***, which correspond to 0.10, 0.05 and 0.01, respectively.
Cons. Mandate Costs %Ext %Act %FoF %LP #Funds # Obs. Panel A: Performance and characteristics for all real estate assets
All assets -2.35*** 0.52*** 570 2,985 [0.42] [0.10] All assets 1.45 -1.63*** -3.38*** 570 2,985 [0.89] [0.49] [1.08] All assets -1.14 0.48*** -1.17*** -2.87*** 570 2,985 [0.70] [0.09] [0.42] [0.89] All assets -0.78 0.45*** -0.75** -0.79** -2.21*** 570 2,985 [0.77] [0.09] [0.30] [0.37] [0.80]
Panel B: Performance and characteristics by real estate subcategory
REITs -6.51** 0.81*** 2.27 1.74 166 601 [2.76] [0.32] [2.04] [1.50] REITs -7.08* 0.87** -0.40 2.26 2.10 166 601 [3.30] [0.36] [1.27] [1.53] [1.33] Direct RE -0.90 0.44*** -1.23*** -3.39*** 1.48 543 2,869 [0.89] [0.08] [0.43] [1.06] [1.58] Direct RE -0.35 0.41*** -0.89*** -0.90** -2.67*** 1.67 543 2,869 [1.00] [0.08] [0.32] [0.37] [0.85] [1.48]
Panel C: Performance and characteristics by investment approach
Internal -1.79 0.60*** 130 665 [1.25] [0.22] Internal -1.30 0.58** -2.13 130 665 [2.18] [0.27] [3.18] External -2.14*** 0.46*** 519 2,520 [0.44] [0.10] External -1.32* 0.43*** -0.86** 519 2,520 [0.73] [0.10] [0.37]
Table C.2: Regression results: performance persistence
The net benchmark-adjusted returns are constructed after deducting the costs and self-declared bench- mark returns from pension fund real estate returns. Pension funds are placed into quintiles based on their total net benchmark-adjusted returns (Panel A), direct real estate returns (Panels B and C) and REIT returns (Panel D). In Panel C, we investigate the persistence in the performance of pension fund direct real estate investments over a two-year horizon to control for possible short-term smoothing of the returns. In Panel D, the analysis of persistence in performance of pension fund REIT investments is based on the 1998-2009 period, whereas in the other panels we employ the entire sample period. The coefficients in the table present the marginal effects after an ordered logit model. The dependent vari- able is the quintile ranking based on returns in year t. We show the marginal effects for the probability to be ranked in the quintile with lowest and in the quintile with the highest returns. The Rank(t−1)
variable is the quintile ranking in the previous year. The Rank(t−2)variable is the quintile ranking two
years ago. We also include the following variables: Mandate - log of total holdings in real estate (Panel A), log of REIT holdings (Panel B) or log of direct real estate holdings (Panels C and D), Costs - total costs for investing in real estate, REITs or direct real estate, %Ext - percentage of investments in external mandates, %Act - percentage in active mandates, %FoF - percentage in fund-of-funds, and %LP - per- centage in limited partnerships. The marginal effects are estimated at the median values. In the ordered logit model we also add year dummy variables and cluster the standard errors by funds. We report standard errors in brackets and significance levels with *, ** and ***, which correspond to 0.10, 0.05 and 0.01, respectively.
Rank(t−1) Rank(t−2) Mandate Costs %Ext %Act %FoF %LP YD
Panel A: All real estate assets
Low ranking -0.054*** -0.016*** 0.059*** 0.033* 0.002 Yes
[0.007] [0.004] [0.019] [0.020] [0.062]
High ranking 0.045*** 0.013*** -0.048*** -0.027* -0.002 Yes
[0.006] [0.003] [0.017] [0.016] [0.051]
Panel B: Direct real estate (one-year persistence)
Low ranking -0.053*** -0.013*** 0.045*** 0.042** 0.022 0.039 Yes [0.006] [0.004] [0.017] [0.018] [0.046] [0.045] High ranking 0.048*** 0.012*** -0.041** -0.038*** -0.020 -0.035 Yes
[0.006] [0.003] [0.017] [0.015] [0.042] [0.041] Panel C: Direct real estate (two-year persistence)
Low ranking -0.018*** -0.016*** 0.074*** 0.058** 0.087* 0.039 Yes [0.005] [0.005] [0.021] [0.025] [0.050] [0.062] High ranking 0.015*** 0.014*** -0.062*** -0.049*** -0.073* -0.033 Yes
[0.005] [0.004] [0.020] [0.019] [0.041] [0.052] Panel D: REITs (1998-2009)
Low ranking -0.010 -0.021* -0.037 -0.025 -0.086** Yes
[0.011] [0.012] [0.068] [0.041] [0.036]
High ranking 0.009 0.018* 0.031 0.022 0.074* Yes
Conclusion
6.1
Agency conflicts among defined benefit pension funds
In investment management, pension funds and other institutions serve as agents that enable the principle, plan members, to save for retirement or reach other financial goals. People rely on DB pension funds to manage their wealth because these funds provide insurance to members against the risk of outliving their assets by allowing for intergenerational and intragenerational risk sharing (Ball and Mankiw, 2007; Davidoff, Brown, and Diamond, 2005). However, DB pen- sion funds also serve as agent for multiple principles: different generations of plan members as well as for the taxpayers, if the pension benefits are explicitly or implicitly guaranteed. In this dissertation, I show that this agency relations in DB retirement systems could create two agency conflicts.
First, different generations of plan members have opposing interests when the pension fund is underfunded. Current stakeholders have an incentive to postpone restructuring the pension benefit promises and to transfer the underfunding risk to future generations. Chapter 2 shows that pension fund asset allocation decisions implemented by the current generation can be influenced by the regulatory incentives to mask funding problems and shift the risk to future generations as well as to taxpayers.
Second, when people delegate the management of their retirement saving to pension funds, plan members trade off higher anticipated returns from these intermediaries against the in- creased difficulty in coordinating their risk-taking and the greater uncertainty about their true incentives and skills. The management of retirement assets involves multiple levels of inter- mediaries, such as pension fund executives, asset managers, placement agents, consultants and actuaries. Chapters 4 and 5 show that multiple layers of intermediation result in higher investment costs and lower performance, especially in alternative assets.
Both of these agency conflicts can be reduced substantially by greater transparency in the pension fund reporting of financial situation as well as in the relations between pension funds and asset management intermediaries.
6.1.1 Implications for pension fund regulation
My research on U.S. public pension funds documents that their regulation permits the current generation to shift concealed funding deficits to future generations by using liability discount rates based on the expected rate of return, not the riskiness of promised pension benefits. This regulation can lead to substantial intergenerational redistribution of wealth and I argue that the policy pertaining to U.S. public pension funds needs a reform.
Pension fund accounting standards should promote transparency, which includes making fair disclosure of the funding situation. The current regulation of U.S. public pension funds permits smoothing of the asset value and discounting the liabilities with the expected rate of re- turn. These valuation rules obscure pension plans true funding status and impact pension fund planning, budgeting and restructuring. In 2010, the average self-declared funding ratio of U.S. public pension funds, estimated using these rules, was equal to 75 percent. In order to over- come this significant underfunding, the vast majority of U.S. public pension funds would have to modify the pension deal. However, restructuring of the contribution rates and promised pension benefits cannot be successful and fair across generations, if it is based on self-reported funding ratios which do not reflect the financial situation. Hence, increasing the transparency in U.S. public pension fund reporting is a necessary precondition before discussing the poten- tial reforms.
In my policy implications, I do not want to make any assertion about the optimal fund- ing level of pension plans. Ricardo (1820) postulates that it is irrelevant for the public welfare whether the current spending is financed with debt or taxes. However, the Ricardian equiv- alence is applicable to the intergenerational consequences of public pension debt only if the current and future generations are informed about the level of pension plan underfunding and state indebtedness. The current regulation of U.S. public pension funds camouflages their funding situation and indirectly the state indebtedness, making it difficult for people to esti- mate the magnitude of intergenerational transfers. I believe that it is important to provide the plan members and taxpayers with accurate estimates of pension fund financial situation and their projected cash-flows in order to enable them to make sound financial decisions.
6.1.2 Implications for pension fund investment management
The investment management of retirement assets involves many intermediaries, such as pen- sion fund boards and executives, asset managers, placement agents and consultants. These intermediaries provide expertise in information gathering and scale advantages in investment costs. However, the multiple layers of intermediation can also create agency conflicts and mis- alignment of objectives, which will reduce the retirement wealth of plan participants.
DB pension funds are among the largest institutional investors. The large size enables them to obtain scale advantages in information gathering as well as in the investment costs, but also makes DB funds prone to liquidity-related diseconomies of scale. According to Chapter 3, large pension funds experience diseconomies of scale when they invest actively in multiple asset classes, such as equities and bonds. In these assets, some larger pension funds could
have performed better, if they had invested in passive mandates without frequent rebalancing decisions. Instead of focusing on traditional active management, DB pension funds can benefit more from designing dynamic asset allocation and market timing policies.
In alternative assets, institutional investors delegate more than 85 percent of the asset man- agement to financial intermediaries, even though multiple layers of intermediation result in higher investment costs and lower performance. These results suggest that part of the delega- tion decisions of pension funds may be made sub-optimally and driven by considerations other than where the best investment opportunities. For instance, institutional investors may retain underperforming intermediaries because delegation reduces their anxiety about taking risk as compared to internal investing. Pension funds delegating the asset management to interme- diaries in order to shift responsibility perceive the returns delivered by these intermediaries as less risky than those delivered by an internal investment division (Gennaioli, Shleifer, and Vishny, 2013; Lakonishok, Shleifer, and Vishny, 1992). If institutional investors delegate the asset management to intermediaries in order to shift responsibility and reduce perceived risk, than they violate their fiduciary duty and do not act in the best interest of their beneficiaries.
Based on Chapters 4 and 5, larger pension funds should evaluate the possibility to re- duce the intermediation by investing internally in alternative asset classes. Smaller pension funds should consider substituting fund-of-funds with other less intermediated investment approaches, and specializing in one alternative asset class, instead of simultaneously investing in multiple alternative assets. If smaller investors do not have sufficient capacity to manage alternative investments, they should invest passively in public equity.