1. Institutional Investors and Infrastructure Investing, 2021, Review of Financial Studies, forthcoming (with Roman Kraussl and Joshua D. Rauh).→ Earlier Version: The Subsidy to Infrastructure as an Asset Class
Institutional investors expect infrastructure to deliver long-term stable returns but gain exposure to infrastructure predominantly through finite-horizon closed private funds. The cash flows delivered by infrastructure funds display similar volatility and cyclicality as other private equity investments, and their performance depends similarly on quick deal exits. Despite weak risk-adjusted performance and failure to match the supposed characteristics of infrastructure assets, closed funds have received more commitments over time, particularly from public investors. Public institutional investors perform worse than private institutional investors, and ESG preferences and regulations explain 25-40% of their increased allocation to infrastructure and 30% of their underperformance.
2. Political Representation and Governance: Evidence from the Investment Decisions of Public Pension Funds, 2018, Journal of Finance, 73(5), pp. 2041-2086 (with Yael V. Hochberg and Joshua D. Rauh).
Representation on pension fund boards by state officials—often determined by statute decades past—is negatively related to the performance of private equity investments made by the pension fund, despite state officials’ relatively strong financial education and experience. Their underperformance appears to be partly driven by poor investment decisions consistent with political expediency, and is also positively related to political contributions from the finance industry. Boards dominated by elected rank‐and‐file plan participants also underperform, but to a smaller extent and due to these trustees’ lesser financial experience.
3. Pension Fund Asset Allocation and Liability Discount Rates, 2017, Review of Financial Studies, 30(8), pp. 2555-2595 (with Rob Bauer and Martijn Cremers).
The unique regulation of U.S. public pension funds links their liability discount rate to the expected return on assets, which gives them incentives to invest more in risky assets in order to report a better funding status. Comparing public and private pension funds in the U.S., Canada, and Europe, we find that U.S. public pension funds act on their regulatory incentives. U.S. public pension funds with a higher level of underfunding per participant, as well as funds with more politicians and elected plan participants serving on the board, take more risk and use higher discount rates. The increased risk-taking by U.S. public funds is negatively related to their performance.
→ Online Appendix
4. Intermediated Investment Management in Private Markets: Evidence From Pension Fund Investments in Real Estate, 2015, Journal of Financial Markets, 22, pp. 73-103 (with Piet Eichholtz and Nils Kok).
We evaluate the economics of financial intermediation in alternative assets by investigating the allocation and performance of pension fund investments in real estate, the most significant alternative asset class for institutional investors. We document substantial heterogeneity in real estate investment cost and performance, determined by two main factors: mandate size and investment approach. Larger pension funds are more likely to invest in real estate internally, have lower costs, and higher net returns. Smaller pension funds invest primarily in direct real estate through external managers and fund-of-funds, and disregard listed property companies. Overall, we find that delegating real estate investment management to financial intermediaries increases costs and disproportionally reduces returns.
5. A Global Perspective on Pension Fund Investments in Real Estate, 2013, Journal of Portfolio Management, 39(5), pp. 32-42 (with Piet Eichholtz and Nils Kok).→ JPM link
6. TIPS, Inflation Expectations, and the Financial Crisis, 2010, Financial Analysts Journal, 66(6), pp. 27-39 (with Florian Bardong and Thorsten Lehnert).
The authors show that inefficiencies in the U.S. market for inflation-linked bonds can be exploited by informed traders who include survey estimates or inflation model forecasts in trades on breakeven inflation. The Treasury Inflation-Protected Securities market has yet to fulfill investors’ expectations as a low-risk, efficient, and liquid financial instrument.
1. The Return Expectations of Institutional Pension Investors, 2020 (with Joshua D. Rauh).
Analysis of required expected return disclosures by public pension funds in individual asset classes reveals a reliance on past performance in setting return expectations. These extrapolative expectations operate through the expected risk premium and occur across all risky asset classes. Pension plans act on their extrapolated expectations by adjusting their target asset allocations. Pension funds extrapolate performance more when executives have personally experienced a longer performance history with the fund, and when employing certain investment consultants. The results cannot be explained by differential risk-taking, persistent investment skill, efforts to reduce costly rebalancing, or fiscal pressure from unfunded liabilities.
2. Delegated Investment Management in Alternative Assets, 2020.
Institutional investors delegate 85% of their alternative investments to external managers and funds-of-funds. Institutions using financial intermediaries have higher costs and underperform institutions investing internally in real assets, private equity, and hedge funds. Large investors rely less on intermediaries, pay lower fees, and obtain higher returns, but small investors that specialize in one alternative asset class manage to overcome the scale disadvantages. For most institutional investors, alternative assets do not deliver returns above public equities. I estimate that small investors would have obtained 3 percentage points higher annual returns had they invested passively in public equities rather than alternative assets.
3. Financial Sophistication and Conflicts of Interest: Evidence from 401(k) Investment Menus, 2019 (with Mike Qinghao Mao).
We analyze the investment menus offered within 401(k) pension plans to the employees of the largest finance and non-finance firms. Within the sample of finance firms, we distinguish between finance firms that hire an external independent trustee and finance firms that serve also as a trustee of their own pension plan. We find that employees of finance firms with an external trustee invest less in sponsor equity and options affiliated with the trustee as compared to those of non-finance firms and of finance firms with an internal trustee. The changes of mutual funds on the investment menu offered by finance firms with an independent trustee are also more sensitive to past performance and their plan participants benefit from the removal of underperforming mutual funds. These findings suggest that greater financial sophistication among plan participants and the sponsoring company can improve the quality 401(k) menus, but only when it is accompanied with an independent governance structure.
4. Can Large Pension Funds Beat the Market? Asset Allocation, Market Timing, Security Selection and the Limits of Liquidity, 2012 (with Rob Bauer and Martijn Cremers).
We analyze the three components of active management (asset allocation, market timing and security selection) in the net performance of U.S. pension funds and relate these to fund size and the liquidity of the investments. On average, the funds in our sample have an annual net alpha of 89 basis points that is evenly distributed across the asset allocation, market timing, and security selection components. Stock momentum fully explains the positive alpha in security selection, whereas “time series momentum” drives market timing. While larger pension funds have lower investment costs, this does not lead to better net performance. Rather, all three components of active management exhibit substantial diseconomies of scale directly related to illiquidity. Our results suggest that especially the larger pension funds would have done better if they invested more in passive mandates without frequent rebalancing across asset classes.