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Stock market performance and pension fund investment policy: rebalancing, free float, or market timing

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  • J.A. Bikker
  • D.W.G.A Broeders
  • Jan de Dreu

Abstract

This paper is the first that examines the impact of stock market performance on the investment policy of pension funds. We find that stock market prices influence the asset allocation of Dutch pension funds in two ways. In the short term, outperformance of equities over bonds and other investment categories automatically results in a higher actual equity allocation (and vice versa), as pension funds do not continuously rebalance their investment portfolios. Each quarter, pension funds rebalance, on average, around 39 percent of excess equity returns, leaving 61 percent for free floating. In the medium term, outperformance of equities induces pension funds to increase their strategic equity allocation (and vice versa). These findings suggest that the investment policies of pension funds are partially driven by the cyclical performance of the stock market. Pension funds respond asymmetrically to stock market shocks: rebalancing is much stronger after negative equity returns. On average, this strategy led to negative excess returns over the period under consideration. Investment policies of large funds deviate from that of small funds: they hold more equity and their equity allocation is much more strongly affected by actual equity returns, reflecting less rebalancing. The largest funds react highly asymmetrically to positive excess equity returns, adjusting their portfolios by significantly more than 100%, reflecting ‘overshooting’ of free floating, or positive feedback trading. Apparently, managers of large funds demonstrate great risk tolerance, particularly in bull markets.

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Bibliographic Info

Paper provided by Utrecht School of Economics in its series Working Papers with number 07-27.

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Length: 22 pages
Date of creation: 2007
Date of revision:
Handle: RePEc:use:tkiwps:0727

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Keywords: Pension fund returns; portfolio choice; excess returns; strategic equity allocation; size effects; asymmetrical behavior;

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Citations

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Cited by:
  1. J.A. Bikker & T. Knaap & W.E. Romp, 2011. "Real Pension Rights as a Control Mechanism for Pension Fund Solvency," Working Papers 11-15, Utrecht School of Economics.
  2. Jan de Dreu & J.A. Bikker, 2009. "Pension fund sophistication and investment policy," Working Papers 09-13, Utrecht School of Economics.
  3. J.A. Bikker & Dirk W. G. A Broeders & David A. Hollanders & Eduard H. M. Ponds, 2009. "Pension funds’ asset allocation and participant age: a test of the life-cycle model," Working Papers 09-25, Utrecht School of Economics.
  4. Sergio, Bianchi & Alessandro, Trudda, 2008. "Global Asset Return in Pension Funds: a dynamical risk analysis," MPRA Paper 12011, University Library of Munich, Germany, revised 14 Jun 2008.
  5. Dirk Broeders & An Chen & Birgit Koos, 2014. "Utility-equivalence of pension security mechanisms," DNB Working Papers 414, Netherlands Central Bank, Research Department.
  6. de Dreu, Jan & Bikker, Jacob A., 2012. "Investor sophistication and risk taking," Journal of Banking & Finance, Elsevier, vol. 36(7), pages 2145-2156.
  7. Senderski, Marcin, 2014. "Assessing the strictness of portfolio-related regulation of pension funds: Rethinking the definition of prudent," MPRA Paper 56610, University Library of Munich, Germany.

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