Working Paper: CEPR ID: DP7679
Authors: David Blake; Allan G. Timmermann; Ian Tonks; Russ Wermers
Abstract: The past few decades have seen a major 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 (as funds grow larger) and adding managers with different strategies before performance deteriorates. 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 rationally anticipate the difficulty of coordinating multiple managers by allocating reduced risk budgets to each manager, which helps to compensate for the suboptimal diversification that results; sponsors also benefit from alpha diversification when employing multiple fund managers. Overall, our results provide support for pension fund sponsors, at least on average, rationally choosing their delegation structure.
Keywords: Asset Management; Decentralized Management; Pension Funds; Principal-Agent Problems
JEL Codes: G11; G23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| specialist managers (M54) | superior security selection skills (G11) |
| increased competition (L13) | better risk-adjusted returns (G11) |
| sponsors reduce risk budgets (Z23) | rational adjustment to coordination challenges (P11) |
| decentralized management structure (M54) | enhanced overall performance of pension funds (G23) |
| decentralized investment management (G11) | improved performance (D29) |
| switch to multiple managers (C34) | enhanced performance (D29) |
| transition from balanced to specialist managers (M54) | improved performance (D29) |