That’s the conservative estimate of how much money institutional pension managers cost their participants in lost investment returns, according to the Stewart et al. article that appeared in the Financial Analysts Journal. Stewart examined the PSN database of pension funds from 1984 to 2007 and cleverly constructed flow portfolios based on what asset classes were reduced and which were increased. It turns out that institutions are just as bad as retail investors in knowing when to enter or exit an asset class or style. Stewart’s conclusion:
The preceding analyses show that plan sponsors are not acting in their stakeholders’ best interests when they make rebalancing or reallocation decisions concerning plan assets. Portfolios of products to which they allocate money underperform compared with the products from which assets are withdrawn. Performance is lower over one- and three-year periods and shows no signs of reversal even after two more years.
It’s kind of sad. Institutions have access to top-tier consulting firms to help them select managers and make allocation decisions, yet still they struggle to do it properly. Volatility is the culprit. If institutions were cleverly buying when a strategy was out of favor, their results would be best with the high volatility products. Instead, their results were negative across the board-and worst of all in the high volatility products. They are practicing emotional asset allocation in the same way as retail investors! Patience is clearly an undervalued asset. Stewart points out:
Clearly, plan sponsors could have saved hundreds of billions of dollars in assets if they had simply stayed the course.
I think there are at least two important take-aways from this paper. 1) Measure twice, cut once. That’s something my junior high shop teach taught everyone. Do your due diligence carefully. Make sure you have data backing the effectiveness of the strategy. Once you cut, you’re done-leave it alone. 2) Be suspicious of where the asset flows are going. As Stewart shows, the flow-weighted portfolios performed terribly. The assets and products that no one wanted are what performed the best. In other words, buy into your strategies when they are out of season. (And maybe think twice about mimicking the huge flows into bonds that have been happening recently. What asset are people dumping? Domestic equities…hmmm.)
For a link to the complete paper that appeared in the Financial Analysts Journal, click here.
