Portfolio allocation for public pension funds

Abstract

This paper presents a model of a public pension fund's choice of portfolio risk. Optimal portfolio allocations are derived when pension fund management maximize the utility of wealth of a representative taxpayer or when pension fund management maximize their own utility of compensation. The model's implications are examined using annual data on the portfolio allocations and plan characteristics of 125 state pension funds over the 2000-2009 period. Consistent with agency behavior by public pension fund management, we find evidence that funds chose greater overall asset -liability portfolio risk following periods of relatively poor investment performance. In addition, pension plans that select a relatively high rate with which to discount their liabilities tend to choose riskier portfolios. Moreover, consistent with a desire to gamble for higher benefits, pension plans take more risk when they have greater representation by plan participants on their Boards of Trustees.

Does past performance affect mutual fund tracking error in Taiwan?

“…For the eight models, previous studies obtain the following inferences regarding the regression coefficients: a 2 , β 1 , β 2 and δ 1 . That is, a 2 > 0 in Chen and Pennacchi (2009); β 1 < 0 and δ 1 > 0 in Brown et al (1996), Chevalier and Ellison (1999), Chen and Pennacchi (2009), Pennacchi and Rastad (2011) and Basak and Makarov (2012); β 1 ¼ 0 and δ 1 ¼ 0 in Renneboog et al (2011) and Cullen et al (2012); β 2 < 0 in Kempf and Ruenzi (2008); and β 2 ¼ 0 in Chen and Pennacchi (2009).…”

“…Furthermore, Starks (1987) studied the influence of manager performance incentive fees on portfolio management decisions. Additionally, Pennacchi and Rastad (2011) found that public pension select higher asset-liability portfolio risk following periods of poor investment performance.…”

Liability-Driven Investment with DownsideRisk

“…In particular, the manager swings for the fences as funding ratios decrease. There is some empirical evidence for this behavior, as Addoum, van Binsbergen, and Brandt [2010] and Pennachi and Rastad [2011] found. Addoum, van Binsbergen, and Brandt [2010] showed that pension plans approaching a funding ratio of 80%, which subject plan sponsors to severe mandatory additional contributions, increase portfolio risk.…”

“…They also found similar but weaker results at a threshold of 100%, where there are milder required contributions. Pennachi and Rastad [2011] found that public pensions funds choose riskier portfolios following periods of relatively poor investment performance, after their funding ratios have declined.…”

Lending, Investments and the Financial Crisis

“…Despite in mutual funds evidence supports the existence of diseconomies of scale because of organizational and liquidity issues (for instance , pension funds experience limited organizational diseconomies and positive economies of scale in asset management activities, especially towards private equity and real estate (Dyck and Pomorski, 2011). Pennacchi and Rastad (2011) investigate the optimal portfolio allocation of pension funds, finding that they retain greater risks after periods of poor investment performance, when liabilities are discounted at higher rates and participants are highly represented in governance bodies. Finally, Crossley and Jametti (2013) find that where guarantees on benefits are present, pension funds take higher levels of portfolio risk.…”