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Decentralized Investment Management: Evidence from the Pension Fund Industry

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  • DAVID BLAKE
  • ALBERTO G. ROSSI
  • ALLAN TIMMERMANN
  • IAN TONKS
  • RUSS WERMERS

Abstract

The past few decades have seen amajor shift from centralized to decentralized investment management by pension fund sponsors, despite the increased coordination problems that this brings. Using a unique, proprietary dataset of pension sponsors and managers, we identify two secular decentralization trends: sponsors switched (i) from generalist (balanced) to specialist managers across asset classes and (ii) from single to multiple competing managers within each asset class. We study the effect of decentralization on the risk and performance of pension funds, and find evidence supporting some predictions of recent theory on this subject. Specifically, the switch from balanced to specialist managers is motivated by the superior performance of specialists, and the switch from single to multiple managers is driven by sponsors properly anticipating diseconomies-of-scale within an asset class (as funds grow larger) and adding managers with different strategies before performance deteriorates. Indeed, we find that sponsors benefit from alpha diversification when employing multiple fund managers. Interestingly, competition between multiple specialist managers also improves performance, after controlling for size of assets and fund management company-level skill effects. We also study changes in risk-taking when moving to decentralized management. Here, we find that sponsors appear to anticipate the difficulty of coordinating multiple managers by allocating reduced risk budgets to each manager, as predicted by recent theory, which helps to compensate for the suboptimal diversification that results through an improved Sharpe ratio. Overall, our results indicate that pension fund sponsors, at least on average, rationally choose their delegation structures.

(This abstract was borrowed from another version of this item.)

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Bibliographic Info

Article provided by American Finance Association in its journal Journal of Finance.

Volume (Year): 68 (2013)
Issue (Month): 3 (06)
Pages: 1133-1178

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Handle: RePEc:bla:jfinan:v:68:y:2013:i:3:p:1133-1178

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References

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  11. Grinblatt, Mark & Titman, Sheridan, 1994. "A Study of Monthly Mutual Fund Returns and Performance Evaluation Techniques," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 29(03), pages 419-444, September.
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  13. Coggin, T Daniel & Fabozzi, Frank J & Rahman, Shafiqur, 1993. " The Investment Performance of U.S. Equity Pension Fund Managers: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 48(3), pages 1039-55, July.
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Cited by:
  1. Donnelly, Catherine & Guillén, Montserrat & Nielsen, Jens Perch, 2014. "Bringing cost transparency to the life annuity market," Insurance: Mathematics and Economics, Elsevier, vol. 56(C), pages 14-27.

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