Pension fund asset allocation and performance

In my dissertation, I focus mainly on one type of financial institution: defined benefit (DB) pension funds. In a DB pension fund, the sponsor promises a monthly retirement benefit that is predetermined by a formula based on the employee’s earnings history, tenure of service and age, rather than depending directly on individual investment returns.

The first question this thesis explores is the design of a strategic asset allocation policy. I examine how pension funds modify the asset allocation policy and liability valuation in response to the maturing participant base and declining interest rates. Human capital life-cycle theory suggests that asset allocation and liability discount rate choices should be more conservative as a fund matures. I analyze whether differences in regulation influence the response of pension funds to these two trends that are exogenous to individual pension fund boards’ decisions.

Next, I investigate how pension funds implement the asset allocation policy. Pension funds engage in three asset management decisions: changing the strategic asset allocation policy, market timing and security selection. I explore the role of size and liquidity for pension fund performance in all three asset management components. DB pension funds are particularly interesting vehicles to study the relation between size and performance, because pension fund inflows do not depend on performance, but on actuarial and demographic factors. This longterm liability structure potentially enables DB pension funds to make substantial investments in illiquid assets.

Gradually over time, institutional investors have modified their strategic asset allocation towards increased exposure to alternative assets, such as real estate, private equity and hedge funds. In alternative assets, institutional investors usually do not act as the ultimate portfolio manager, but rather delegate the asset management decisions to financial intermediaries, like external managers and fund-of-funds. I also consider the specialization decision, which captures whether institutions invest only in one alternative asset class, or invest simultaneously in two or three alternative asset classes. My main contribution is to consider how levels of intermediation and specialization relate to costs and performance of institutional investors in alternative assets.