Hyper Activity Is Costing Large US Public Plans, Scholars Say

Large US public pensions are, on average, making alpha—but could be making more if they shifted a greater portion of their portfolios to passive investments, researchers say.

(February 28, 2013) – CIOs and their teams at major public pensions in the United States have been doing something right: A study has found these funds average 89 basis points of alpha per year due to asset management decisions. 

But, according to a study, that number could be even higher if CIOs made the decision to, well, make fewer decisions. “Pension funds benefit significantly from time series momentum across multiple asset classes,” they wrote. “Our results thus suggest that pension funds, and especially the larger funds, would have done better if they invested in passive mandates without frequent rebalancing across asset classes.” 

Authors Aleksandar Andonov, Martijn Cremers, and Rob Bauer (a member of The Professors, aiCIO’s just-released list of the top ten most influential academics in institutional investing) arrived at this finding by analyzing a CEM data set covering 557 US defined benefit plans from 1990 to 2010. Bauer and Andonov, both of Maastricht University, along with Notre Dame’s Cremers, broke down pension fund returns into three components—asset allocation, market timing, and security selection—and found that the second factor contributed a mean of 26 basis points of alpha annually. 

Pension funds earned none of this 0.26% alpha through active rebalancing, however. “The 26 basis points abnormal market timing returns can be fully attributed to passive exposure to ‘time series’ momentum,” the authors wrote. “Time series momentum is the phenomenon that past returns in a particular asset class tend to be predictive for the return in the asset class … Combined with the insignificant security selection performance, this suggests that pension funds benefit from simultaneously investing in multiple asset classes, but would do better (after costs and on average) if they would have invested exclusively in passive mandates without frequent rebalancing across asset classes.” 

 This call for passivity has been echoing from numerous corners of the institutional investing space beyond academia. 

Last week, Lee Partridge of Salient urged the San Diego County Employees Retirement Association to drop certain hedge funds in their portfolio in favor of passive indexes, to take advantage of trend strategies like momentum without paying sky-high fees. 

Likewise, Mercer Partner Brian Birnbaum stressed in a recent interview with aiCIO that going passive can be the best way for institutional investors to boost net returns: “What you want to avoid is having clients buy and pay multiple active manager fees to get exposure or access certain markets. You can do the same thing with index funds.”

Read the entire paper here

Related article: “Who’s Paying What: Tim Walsh, Blackstone, and the Fee Revolution.”