1. 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.
2. 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.
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3. 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.
4. 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
5. 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 Investors, 2018 (with Joshua D. Rauh).
Institutional investors rely on past performance in setting future return expectations, and these extrapolative expectations affect their target asset allocations. Drawing on newly-required disclosures for U.S. public pension funds, a group that manages approximately $4 trillion of assets, we find that cross-sectional variation in past returns contributes substantial power for explaining real portfolio expected returns and expected risk premia in individual asset classes. Pension fund past performance affects real return assumptions across all risky asset classes, including in public equity where the relative performance of institutional investors is not persistent. In private equity, the extrapolation of past performance is driven by stale investments. State and local governments that are more fiscally stressed by higher unfunded pension liabilities assume higher portfolio returns through higher inflation assumptions, but this factor does not attenuate the extrapolative effects of past returns. Pension funds are more likely to extrapolate past performance in settings where they receive support for doing so from their investment consultants, and in which the investment executives have longer tenure and therefore have personally experienced a longer history of past performance with the fund.
2. The Subsidy to Infrastructure as an Asset Class, 2018 (with Roman Kraussl and Joshua D. Rauh).
We investigate the characteristics of infrastructure as an asset class from an investment perspective of a limited partner. While non U.S. institutional investors gain exposure to infrastructure assets through a mix of direct investments and private fund vehicles, U.S. investors predominantly invest in infrastructure through private funds. We find that the stream of cash flows delivered by private infrastructure funds to institutional investors is very similar to that delivered by other types of private equity, as reflected by the frequency and amounts of net cash flows. U.S. public pension funds perform worse than other institutional investors in their infrastructure fund investments, although they are exposed to underlying deals with very similar project stage, concession terms, ownership structure, industry, and geographical location. By selecting funds that invest in projects with poor financial performance, U.S. public pension funds have created an implicit subsidy to infrastructure as an asset class, which we estimate within the range of $730 million to $3.16 billion per year depending on the benchmark.
3. Delegated Investment Management in Alternative Assets, 2014.
This paper investigates the institutional investor allocations to real assets, private equity and hedge funds. Institutional investors delegate 85 percent of the asset management of their alternative investments to external managers and fund-of-funds. Institutions relying on these financial intermediaries underperform institutions investing internally (directly) in all three alternative asset classes. Fund size is the most important determinant of the degree of investor sophistication: larger funds pay lower fees, invest relatively more internally, and select better external managers. Larger funds experience diseconomies of scale when investing only in one alternative asset class, while smaller investors obtain better performance when specializing in one alternative asset class instead of simultaneously investing in real assets, private equity and hedge funds. On a net return basis, smaller institutional investors would have obtained at least 2 percentage points higher annual returns had they invested passively in public equities rather than alternative assets over the 1990-2011 time period.
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.