When pension funds share key players, like asset managers, actuaries and trustees, do they flock to the same asset allocation regardless of differences in liabilities?
In a new working paper Pension funds interconnections and herd behaviour, Rob Bauer, Matteo Bonetti and Dirk Broeders from Maastricht University set out to see how much influence sharing key players has in causing plans to take on a herd mentality.
The authors look at 191 Dutch pension funds to see if there is an effect of interconnections on their strategic investment decisions to alternative assets. They looked at the period of 2007 to 2016 using proprietary data provided by De Nederlandsche Bank.
The paper highlighted that pensions in the Netherlands are a good sample to study because the institutional investors are highly interconnected- it is a small country but has a very large pension sector. Therefore, there are many asset managers and actuarial firms that work for multiple plans.
The paper looks at trustees, actuaries and dominant asset managers who provide services to multiple pension funds. A dominant asset manager is considered a manager that has worked with the plan for a long period, consistently through 2009 to 2016, and who manages a sizable share of the portfolio of each fund, Bonetti says.
“Here is the Netherlands we observed that many pension funds have very similar portfolios, especially in alternative investments, and we also observed that there are a lot of interconnections in their governance structure,” Bonetti says, specifically highlighting that the percentage of a portfolio allocated to alternatives is similar.
The paper found that pension funds interconnected through individual actuaries or dominant asset managers change their strategic allocations in the same direction over time.
More specifically, the paper found that “a pension fund interconnected to two other pension funds through the same dominant asset manager will increase on average its allocation to alternative investments by 2.5 percent if both pension funds increase their allocation by 10 percent, all else being equal,” the paper said.
The paper specifically looked at alternatives because it said that these are harder to understand with less information availability and require specific expertise. “These attributes make skilled and experienced asset managers very influential players in the investment decision process,” the paper said.
More specifically, the research found that pension funds interconnected through a dominant asset manager showed herd behavior in all alternative assets, except real estate, as well as other standard asset classes like stocks and bonds.
When it comes to sharing an individual actuary, the paper also found herd behaviour for investing in alternative asset classes, including private equity and real estate allocation.
For trustees that overlapped among plans, the paper found little evidence of herding.
“If you look at it from the perspective of a pension fund, the board of a pension fund of course wants to know whether the decisions they make are independent and that they are really good for their own pension fund,” says Bauer. He says that if the Board is prone to herding it may be something that they don’t want.
Bauer says there are pension funds with various sizes and if you are a very small fund it is difficult to efficiently manage private assets. “If you are in private assets, you should be in it for the right reason and not because of the fact that someone who you have a network connection with is also doing it,” he says.