Evaluating the Financial Performance of Pension Funds: An Individual Investor's Perspective

Pension funds require the managerial expertise of financial intermediaries, who must be paid a fee or spread. The spread significantly reduces the value of the pension fund over longer holding periods, and implies significantly greater incentive conflicts for defined contribution-funded pension funds than for defined benefit-funded pension funds. The magnitude of the intermediary spread and those factors affecting the demand for financial intermediary reputation and the marginal fee for this reputation are examined for a sample of 66 defined contribution and 54 defined benefit Australian pension funds during 1991–93. The intermediary spread significantly reduces the average net return provided to individual investors, particularly for defined contribution pension funds. Agency-related factors affecting the demand for financial intermediary reputation and its marginal fee reflect underlying contract-based differences between these types of fund.     

Life-cycle funds: Much Ado about Nothing?

The core idea of life-cycle funds or target-date funds is to decrease the fund's equity exposure and conversely increase its bond exposure towards the fund's target date. Such funds have been gaining significant market share and were recently set as default choice of asset allocation in numerous defined contribution schemes or related old-age provision products in several countries. Hence, an assessment of life-cycle funds’ risk-return profiles – that is, the probability distribution of returns – is essential for sustainable financial planning of a large group of investors. This paper studies the risk-return profile of life-cycle funds in particular compared to simple balanced or lifestyle funds that apply a constant equity portion throughout the fund's term instead. In a Black–Scholes model, we derive balanced funds that reproduce the risk-return profile of an arbitrary life-cycle fund for single and regular contributions. We then analyze the accuracy of our results under more complex asset models with stochastic interest rates, stochastic equity volatility and jumps. We further show that frequently used ‘rule of thumb approximations’ that only take into account the life-cycle fund's average equity portion are not suitable to approximate a life-cycle fund's risk-return profile. Our results on the one hand facilitate sustainable financial planning and on the other hand challenge the very existence of life-cycle funds since appropriately calibrated balanced funds can offer a similar (often dominating) risk-return profile.     

Recent changes in disclosure regulation: Description and evidence

Technology has dramatically reduced the cost of disclosing information to investors and created new conduits for securities' sales. The result is stock ownership, both direct and indirect, has never been more widely distributed. Equally important, changes have occurred in the institutional market for new offerings. Bought deals, Internet road shows, the preeminence of mutual funds and pension funds, and foreign investors and issuers have changed the market. In the wake of these changes, the SEC's disclosure policy has evolved. The evidence suggests we have moved from a world where information was released relatively infrequently and with significant lags to a world where information is released relatively rapidly on a continuous basis to as many investors as possible.     

Measuring Longevity Risk: An Application to the Royal Canadian Mounted Police Pension Plan

An employer that sets up a defined benefit pension plan promises to periodically pay a certain sum to each participant starting at some future date and continuing until death. Although both the future beneficiary and the employer can be asked to finance the plan throughout the beneficiary's career, any shortcoming of funds in the future is often the employer's responsibility. It is therefore essential for the employer to be able to predict with a high degree of confidence the total amount that will be required to cover its future pension obligations. Applying mortality forecasting models to the case of the Royal Canadian Mounted Police pension plan, we illustrate the importance of mortality forecasting to value a pension fund's actuarial liabilities. As future survival rates are uncertain, pensioners may live longer than expected. We find that such longevity risk represents approximately 2.8 percent of the total liability ascribable to retired pensioners (as measured by the relative value at risk at the 95th percentile) and 2.5 percent of the total liabilities ascribable to current regular contributors. Longevity risk compounds the model risk associated with not knowing what is the true mortality model, and we estimate that model risk represents approximately 3.2 percent of total liabilities. The compounded longevity risk therefore represents almost 6 percent of the pension plan's total liabilities.     

Equity fund size and growth: Implications for performance and selection

Should individuals choose the largest or smallest equity funds for investment? This study explores the relationship of equity fund size to performance. Historical returns of large funds are found to be superior to their smaller peers. Yesterday's best performing fund's tend to become today's largest funds as individuals invest heavily in response to the communications about the fund's past success. But the findings suggest that, once large, equity funds do not outperform their peers. Especially for funds in aggressive growth objectives, the advantages of being small appear to outweigh the disadvantages. For individual investors wtih aggressive growth objectives, a strategy of investing in smaller funds may thus be wealth maximizing.     

Disclosure of liquidity and cash flow statements by Australian superannuation funds before Covid-19

The Commonwealth's stimulus package required the unexpected distribution of cash by superannuation funds to members during the Covid-19 pandemic. We focus on disclosure and maintenance of an operational risk financial reserve and reporting of the statement of cash flows in annual reports by Australian superannuation funds. These disclosures represent mandated sources of information providing evidence of liquidity levels for meeting cash payouts and disclosure adherence. Many funds did not meet their statutory reporting requirements. More members and higher union board membership as measures of stakeholder power explain higher disclosure in support of managerial stakeholder theory.     

Hedge Fund Regulation and Fund Governance: Evidence on the Effects of Mandatory Disclosure Rules

This paper uses three alternating changes in hedge fund regulation to study whether regulation reduces hedge funds’ misreporting, and, if so, why regulation is effective. Relative to public companies, hedge fund regulation is relatively light. Much of the regime is a “comply‐or‐explain” framework that allows funds to forego compliance with governance rules, providing that they disclose their lack of compliance. The results show that regulation reduces misreporting at hedge funds. Further analysis suggests that the disclosure requirements led funds to make changes in their internal governance, such as hiring or switching the fund's auditor, and that these changes induced funds to report their financial performance more accurately.     

Price sensitivity of the consumer-investor: Evidence from energy prices and mutual fund fees

This study documents a significant relation between changes in commodity prices and investors' price sensitivity in the market for mutual funds. Specifically, price sensitivity⸺defined as the negative relation between fund-level flows and a fund's cost of ownership⸺is more pronounced in periods when energy commodity prices increase sharply. Aggregate flows into actively managed funds relative to the cheaper passively managed funds decrease (increase) when energy prices rise (fall). The results furnish novel evidence supporting an integrated view of the representative “consumer-investor,” whose price sensitivity in choosing financial products is related to price shocks in household consumption goods.     

Compliance with pension‐related mandatory disclosures and debt financing

Using hand‐collected data on the level of pension‐related mandatory disclosures required by International Accounting Standard 19 Employee Benefits, we test whether compliance levels with these disclosures convey information that affects firms’ access to the public instead of the private debt market, as well as the cost of their new debt issues. We document a higher tendency to access the public debt market for firms with higher levels of pension‐related disclosure. Furthermore, we find that firms with higher levels of pension‐related disclosure enjoy a lower cost in terms of issuance of public debt, but not a lower cost for private debt issues. Thus, the benefits of disclosure in reducing information risk are only realisable when creditors rely heavily on financial statements in their decision making, due to the limited access to private information. Additional tests reveal that high compliance levels effectively mitigate the negative effect of pension deficits on the cost of public debt. These findings provide novel evidence in the extant literature on the role of mandatory (and, in particular, pension‐related) disclosures on firms’ debt financing. They also have important policy implications.     

Sovereign pension and social security reserve funds: A portfolio analysis

Sovereign wealth funds (SWFs) have been increasing in numbers and in the global reach of their investment activities. At the same time, they seem to experience the adverse consequences of the financial crisis differently than other financial intermediaries. This paper assesses whether and how a retirement-financing purpose has affected their investment strategies since the global financial crisis, as opposed to the strategies of other public pension entities that do not operate as SWFs. We construct a sample of 12 sovereign pension reserve funds (SPRFs) and social security reserve funds (SSRFs) and analyze the effects of size, operational model, country development, the fund's experience, and quality of disclosures on strategic asset allocation for the period 2007–2014. We also investigate the relevance of “home bias.” Our results show that SPRFs invest more aggressively than SSRFs, but are less exposed to domestic investments. We do not find major shifts in asset allocation induced by the financial crisis, except for a recent decrease of home-country exposures.     

Jumping over a low hurdle: personal pension fund performance

This paper provides a comprehensive analysis of the annual and of the long-term performance of personal pension funds relative to their Primary Prospectus Benchmarks (PPBs) and T-bills. The study covers 9659 personal pension funds from across all 30 ABI investment sectors that operated in the UK in the 1980–2009 period. Of these, 4531 pension funds are compared against their PPBs. The performance measured by ordinary excess returns over the UK T-bills and over PPBs, as well as the Sharpe ratio, Sharpe ratio adjusted for skewness and kurtosis, Sortino ratio in relation to the UK T-bills and PPBs, and the Modigliani–Modigliani measure are calculated for arithmetic, geometric and log returns. We find convincing evidence that pension funds lack challenging long-term performance targets. We argue that the existing PPBs are easy to outperform given that funds are allowed to diversify in assets not included in their PPBs. We discuss policy implications of our findings.     

How the provision of inflation information affects pension contributions: A field experiment

Ignoring the effects of inflation in retirement planning can have severe consequences for an individual's future financial well-being. Yet, many pension funds do not communicate inflation-related information, presumably for the fear of reduced contributions once the members understand how low the “real” return on saving for retirement is. As an alternative prediction, the provision of inflation information could increase pension contributions, because it reveals possible pension shortfalls. In cooperation with a major German pension fund, we conduct a field experiment, in which we vary the inflation information provided to the fund members, to explore this important issue. Among all participants, we find mostly positive but insignificant effects of the inflation information on pension contributions. Among those participants who voluntarily changed their pension contributions after the experimental intervention, the provision of inflation information significantly raises the likelihood of increasing pension contributions.     

Economic consequences of mandatory GAAP changes: The case of SFAS No. 158

This study examines management's reaction to the SFAS No. 158 requirement to recognize previously disclosed post-retirement benefit obligations on the balance sheet. The results indicate that managers attempted to mitigate the impact of the standard by increasing the assumed pension discount rate in subsequent periods. Further, the discount rate choice was related to the magnitude of the SFAS No. 158 balance sheet adjustment. Specifically, firms with larger required liability adjustments and more volatile pension assets and obligations were more likely to increase their discount rates. The findings have important implications for research regarding the economic consequences of accounting regulations and in particular the debate surrounding recognition versus disclosure since they indicate that managers react to the relocation of information from the financial statement footnotes to the balance sheet.     

Meeting new peers: The effects of Morningstar category reassignment on fund flows and star ratings

We investigate how the reassignment of a fund's Morningstar category affects fund flow and Morningstar star rating. We find that funds assigned to a different category gain positive abnormal flows and this effect is significant mainly for high-rated funds. Category reassignment does not improve a fund's star rating on average, and flows are less responsive to a star-rating change if the rating change is likely to be driven by category reassignment. The positive abnormal flows captured by high-rated funds after category reassignment are consistent with a visibility story: some investors filter funds by Morningstar category and star rating, and category reassignment makes a fund more visible to a new group of investors if the fund is highly rated. In contrast, a low-rated fund is likely to be selected only by investors who do not refer to the fund's Morningstar information and, hence, gains little visibility from category reassignment. We also find evidence that more sophisticated investors are more likely to consider not only fund rating but also fund category when evaluating fund performance.     

Determinants of Actuarial Valuation Method Changes for Pension Funding and Reporting: Evidence from the UK

This study examines various factors that potentially explain cross‐sectional variations in UK corporate managerial discretion to switch towards a market‐based actuarial pension valuation method for pension funding and reporting purposes. Evidence is based on accounting, actuarial and share market data for an industry‐matched pair sample of 90 UK firms. Consistent with our hypotheses we find that companies have a greater propensity to switch actuarial methods if they use lower discount rates, lower flow funding ratios and sponsor larger pension plans in the pre‐switch valuation year. These findings are consistent with the traditional perspective, which implies that UK corporate switching decisions are explained by characteristics of their defined benefit pension funds. The results run contrary to the findings of earlier US based studies that find that such choices can be explained from an alternative corporate financial perspective.     

Does short sales deregulation affect qualitative information disclosure?

We examine the impact of short sales deregulation on firms' disclosure of non-financial qualitative information. Our simple analytical model predicts that, after short sales deregulation and when the cost of disclosing proprietary qualitative information to the firm and its executives is sufficiently high, shortable firms respond by disclosing less proprietary and more non-proprietary qualitative information than non-shortable firms. Using a textual analysis of qualitative information about the supply chain, available in the management disclosure and analysis sections of the annual reports of a sample of Chinese firms, and applying a staggered difference-in-differences research design, we find evidence consistent with the model's prediction.     

Politics, Insurance Regulation, and Unfunded Pension Liabilities

ABSTRACT: Insurance regulators operate in an environment in which resources are scarce and issues are most often complex and not salient to affected persons. Consequently, regulatory agencies, such as the Pension Benefit Guaranty Corporation (PBGC), need to use resources efficiently by making issues salient and not complex if regulatory goals are to be attained. To further its goal of full funding of defined benefit pension plans, the PBGC annually published a list of the Top Fifty Companies With the Largest Underfunded Pension Liability (LIST). This article investigates the issue of the economic effects of pension plan disclosure by measuring the share price response of the companies included on the LIST; then policy implications are drawn. The event study findings show that, on average, publication of the LIST did not have a negative effect on firm value. However, cross-sectional analysis provides some support for the contention that publication of the LIST had an economic cost on LISTed firms. The authors' results show that the value of large firms on the PBGC's list is less negatively affected at arrival (ARRIVAL) than smaller LISTed firms. Conversely, when firms leave the list (DEPARTURE), the value of large growth-oriented firms is more negatively affected than the value of other firms that reduce their unfunded pension liability. From a policy perspective, as hypothesized by Meier (1991), the PBGC used its scarce resources effectively by publishing the LIST. The issue of unfunded pension liability became less complex and more salient to interested parties. Consequently, consumer groups and political elites provided their support to further the regulatory agency's stated goal, which was the full funding of defined benefit pension plans. Furthermore, increased awareness of the underfunding problem contributed to the passage of the Retirement Protection Act of 1994.     

Active management, fund size, and bond mutual fund returns

Conventional wisdom holds that bonds are relatively homogenous investments compared to equities. Consequently, factors that explain variation in returns among bond mutual funds may differ in magnitude from those for equity mutual funds. In this study, a time-series cross-sectional analysis is employed to investigate the relationship between a bond fund's risk-adjusted return and specific fund attributes. Results indicate that a bond fund's past performance does not predict future performance and that bond fund managers are generally ineffective at increasing risk-adjusted returns. However, unlike equity mutual funds, bond mutual funds do appear to enjoy economies of scale.     

Conflict of interest and proxy voting by institutional investors

Political pressures can bias public pension funds (PPFs) toward activist shareholders. The pension business ties mutual fund families (MFFs) have with portfolio firms can bias them toward firm management. We examine how these contrasting conflicts of interest affect institutional investors' proxy voting behavior and show PPFs (MFFs) are considerably more supportive of activist shareholders (firm management) in voting, even if doing so may harm investment value. The biases are more pronounced when incentive conflicts are stronger. PPFs support shareholder (management) proposals more (less) when Democrats gain more power in the fund's home state. Conflicted PPFs are particularly active in supporting value reducing shareholder proposals.