Swedroe: Pension Plans & Consultants

March 27, 2019

It seems logical to believe that if anyone could beat the market, it would be the pension plans of large U.S. companies.

  • Given the large sums they control, they have access to the best and brightest portfolio managers—managers most individuals don’t have access to because they cannot meet required minimums.
  • It’s not even remotely possible they ever hired a manager with a record of underperformance.
  • The vast majority of pension plans hire professional consultants to help them perform due diligence in interviewing, screening and ultimately selecting the very best. You can be sure these consultants have thought of every conceivable screen: management tenure, depth of staff, consistency of performance, performance in bear markets, consistency of implementation of strategy, turnover, costs and so on.
  • The fees they pay are much lower than fees individuals pay.

Pension Fund Performance Research

Despite these advantages, the research shows pension plans do not outperform appropriate risk-adjusted benchmarks. We’ll examine the findings from four studies.

The first is the 2007 study “The Performance of U.S. Pension Funds” by Rob Bauer, Rik Frehen, Hubert Lum and Roger Otten, which covered 716 defined benefit plans (1992-2004) and 238 defined contribution plans (1997-2004) and found:

  • Returns relative to benchmarks were close to zero.
  • There was no persistence in pension plan performance.
  • Fund size, degree of outsourcing and company stock holdings were not factors driving performance. This finding refutes the claim that large pension plans are handicapped by their size.

The authors concluded: “The striking similarities in performance patterns over time makes skill differences highly unlikely.”

The 2008 study “The Selection and Termination of Investment Management Firms by Plan Sponsors” by Amit Goyal and Sunil Wahal provides us with further evidence on the inability of plan sponsors to identify investment management firms that will outperform the market after they are hired.

The authors examined the selection and termination of investment management firms by plan sponsors. The database covered approximately 3,700 plan sponsors from 1994 to 2003. The following summarizes their findings:

  • Plan sponsors hire investment managers after those managers earn large positive excess returns up to three years prior to hiring.
  • Post-hiring excess returns are indistinguishable from zero.
  • If plan sponsors had stayed with the fired investment managers, their returns would have improved.

The bottom line: All the activity was counterproductive.

Additional Findings

The 2000 study “A Panel Study of U.S. Equity Pension Fund Manager Style Performance” found similar results. Authors T. Daniel Coggin and Charles Trzcinka studied the performance of 292 pension plans with 12 quarters of data up to the second quarter of 1993. The following summarizes their findings:

  • It is very difficult to find investment managers who consistently add value relative to appropriate benchmarks.
  • No correlation was found between relative performance in one period and future periods.
  • There was no evidence the number of managers beating their benchmarks was greater than pure chance.

Coggin and Trzcinka concluded: “Those relying on historical data on returns are likely to be disappointed.”
Tim Jenkinson, Howard Jones and Jose Vicente Martinez, authors of the 2013 study “Picking Winners? Investment Consultants’ Recommendations of Fund Managers,” examined the aggregate recommendations of consultants with a share of more than 90% of the U.S. consulting market. They found that the consultants’ recommendations of funds are driven largely by soft factors rather than the funds’ past performance. They also found that while their recommendations have a very significant effect on fund flows, there is no evidence that these recommendations add value to plan sponsors.           

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