Stock market performance and pension fund investment policy: rebalancing, free float, or market timing?

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1 Fnal veson IJCB Sock make pefomance and penson fund nvesmen polcy: ebalancng fee floa o make mng? Jacob A. Bkke ab Dk W.G.A. Boedes a and Jan de Deu c Ocobe Absac hs acle examnes he mpac of sock make pefomance on he nvesmen polcy of penson funds. We fnd ha sock make pces pefomance he asse allocaon of Duch penson funds n o ays. In he sho em oupefomance of eques ove bonds and ohe nvesmen caegoes auomacally esuls n a hghe acual equy allocaon (and vce vesa) as penson funds do no connuously ebalance he nvesmen pofolos. ach quae penson funds ebalance on aveage aound 39 pecen of excess equy euns leavng 6 pecen fo fee floang. In he medum em oupefomance of eques nduces penson funds o ncease he saegc equy allocaon (and vce vesa). hese fndngs sugges ha he nvesmen polces of penson funds ae paally dven by he cyclcal pefomance of he sock make. We also fnd ha ebalancng s much songe afe negave equy euns ndcang ha penson funds espond asymmecally o sock make shocks.. Fuhemoe nvesmen polces of lage funds devae fom ha of small funds: hey hold moe equy and he equy allocaon s moe songly affeced by acual equy euns eflecng less ebalancng. he lages funds eac hghly asymmecally o equy euns. he posve excess equy euns lead o adjusmens n equy pofolos of moe han 00% eflecng oveshoong of fee floang o posve feedback adng. Appaenly manages of lage funds have geae sk oleance paculaly n bull makes. JL Classfcaon Codes: G G23; Keyods: Asse euns pofolo choce feedback adng myopa asymmecal behavo penson fund sze.. a De Nedelandsche Bank (DNB) Supevsoy Polcy Dvson Saegy Depamen P.O. Box 98 NL-000 AB Amsedam he Nehelands j.a.bkke@dnb.nl d..g.a.boedes@dnb.nl. b Unvesy of Uech School of conomcs Janskekhof 2 NL-35 BL Uech he Nehelands. c RBS Global Bankng & Makes 35 Bshopsgae London C2M 3UR UK jan.de.deu@bs.com. he auhos ae gaeful o an anonymous efeee Guus Boende Aed Houben heo Njman and semna pacpans a he DNB eseach semna of 9 Febuay 2008 he Roman Inenaonal Cene fo Penson Managemen 2008 (oono) he Mdes Fnance Assocaon 2008 (San Anono) and he SURF Colloquum Ne ends n Asse Managemen 2008 (Munch) fo valuable commens and suggesons and o Jack Bekooj fo excellen suppo n consucng he daase. he ves expessed n hs acle ae pesonal and do no necessaly eflec hose of DNB o RBS.

2 2 Inoducon he opmal equy allocaon of penson funds s subjec o consdeable debae. A hgh pecenage of asses nvesed n eques esuls n sgnfcan exposue of penson ealh o flucuaons n sock make pces. Whle nomnal defned-benef penson lables ae bes esembled by bond euns consdeable equy holdngs may be opmal hen ndexaon of benefs s conngen on he fundng ao of he penson fund. Dung he nnees abundan equy euns led o pemum educons and even conbuon holdays fo penson plan sponsos. Hoeve he sks of equy holdngs sufaced afe he collapse of he sock make n hch esuled n lage losses fo penson funds. In eacon penson benefs ee cualed and conbuons seeply nceased. hs epsode movaed ased a debae on he nvesmen saeges of Duch penson funds and paculaly on he exposue o equy makes. he nvesmen saegy of Duch penson funds s of key mpoance o socey as nvolves moe han 600 bllon n asses o ove pe nhaban. he ay n hch hese asses ae nvesed has a sgnfcan nfluence on he level of equed pemums o fnal benefs. A one pecen loe annual eun ove he lfecycle of a ypcal oke anslaes no 27 pecen loe accumulaed penson asses. 2 Consequenly one of he mos mpoan esponsbles of penson funds usees s o maxmze he expeced eun on asses a an accepable level of sk e.g. measued n ems of he pobably of undefundng. hs sudy nvesgaes hehe sock make pefomance nfluences penson funds nvesmen polces. In pacula e examne o ays n hch sock make pefomance mpacs he equy allocaon of penson funds: () n he sho em as a esul of make mng o mpefec ebalancng and () n he medum em as a esul of adjusmens o he saegc asse allocaon. able pesens he asse allocaon of Duch penson funds ove he follong fve boad classes: ques Bonds Real sae Cash and Ohe Asses. Penson fund nvesmen polcy ncludes he saegc asse allocaon decson hch efes o choosng he nvesmen pecenages n each asse class. Of he afoemenoned asse classes eques have he hghes expeced eun bu also he hghes volaly. Fo mos penson funds s he lages asse caegoy. Consequenly equy Nomnal defned benef penson lables ae bes esembled by nomnal govenmen bonds. Insead defned benef penson lables ha ae fully ndexed o pces ae bes esembled by nflaon lnked bonds. In many Duch defned benef penson deals ndexaon s conngen on he fundng ao of he penson fund. he make value of hs conngen ndexaon can be deved usng opon pcng heoy. In hs case mgh be opmal o have consdeable equy exposue see e.g. Boedes (2006). 2 he hee man componens deemnng he coss of pensons ae he qualy of he penson scheme he ae of eun on nvesmens and admnsave and nvesmen coss (see also Bkke and De Deu 2009).

3 3 allocaon s one of he key polcy vaables deemnng he sk-eun pofle of a gven penson fund. able : Penson fund saegc and acual asse allocaon 999:I 2006:IV (n %) Asse classes Aveage saegc asse allocaon Sandad devaon Aveage acual asse allocaon Sandad devaon ques Bonds Real sae Cash 0 Ohe oal Noe: he asse shaes ae aveages ove Duch penson funds eghed by oal nvesmens. Souce: De Nedelandsche Bank. Penson funds geneally deemne he saegc asse allocaon polces usng asse and lably managemen sudes n hch hey consde long-em expeced euns eun vaances and covaances of boad asse classes gven he sze and chaacescs of he penson lables see e.g. Campbell and Vcea (2002). 3 he saegc asse allocaon s ypcally se on a hee o fve yea hozon. Fo many penson funds he saegc asse allocaon ncludes banddhs fo he acual asse allocaon o df. Fo hs pupose a accal sk budge can be made avalable. hese banddhs ae chosen n such a ay ha he maxmum ex ane ackng eo does no exceed a gven heshold. hs ackng eo () s usually defned as = ' Σ hee s he veco of acual pofolo eghs mnus he veco of saegc pofolo allocaon and Σ s he vaance-covaance max. In hs acle ebalancng s nepeed as a eun o he mdpon of hese banddhs. As nvesmen oppounes change ove me devaons n expeced euns fom he long-em aveages may aan changes n he nvesmen mx. 4 Choosng acual pofolo eghs ha devae fom he saegc asse allocaon s knon as accal asse allocaon o make mng. Make mng efes o akng sho-em (nfomed) bes on he elave asse class euns. I can be mplemened hough acually buyng and sellng he undelyng secues alhough n pacce devaves ae also commonly used as an effcen manne o change a fund s asse allocaon. Hoeve he poenal exa eun hough make mng s lmed as ndcaed also by he so-called fundamenal la of acve managemen see Gnold and Kahn (999). 5 3 Shefn and Saman (997) use behavoal fnance heoy o explan he asse allocaon of penson funds. hey ague ha nvesos buld pofolos as pyamds of asses laye by laye. In conas o mean-vaance heoy covaance beeen asse classes ae geneally gnoed esulng n subopmal pofolos. 4 Pedcably n expeced asse euns may affec he opmal pofolo choce of nvesos h long hozons (see e.g. Babes 2000; Paso and Sambaugh 200). 5 hs la saes ha he nfomaon ao equals he nfomaon coeffcen mes he squae oo of he numbe of ndependen nvesmen decsons. he nfomaon ao s he sk-adjused excess eun ove a passve nvesmen saegy. An nfomaon ao of 0.5 hch s consdeed hgh eques ha asse manages ean a 50 bass pons excess eun ( alpha ) pe pecen of esdual sk on a yealy bass. he nfomaon coeffcen

4 4 hs sudy examnes he mpac ha hghe o loe euns on socks compaed o he ohe asse caegoes have on he equy allocaon of penson funds. o he bes of ou knoledge hs s he fs sudy ha examnes hs elaonshp. Fgue shos he vaous facos ha nfluence he equy Fgue : he mpac of sock make pefomance on equy allocaon Sock Make Pefomance Make mng/ Fee floang Rebalancng Saegc asse allocaon quy Allocaon allocaon of penson funds. Ove he long em equy allocaon s deemned by a fund s saegc asse allocaon. Hoeve seveal facos nfluence asse allocaon n he sho o medum em. We dsngush he follong hee equy nvesmen saeges ha penson funds may use o espond o posve o negave sock make euns: ebalancng fee floa and make mng. Rebalancng efes o he nvesmen pocess appled o ensue ha a fund s acual equy allocaon connuously equals s saegc equy allocaon hch mples sellng eques afe elave hgh sock make euns and buyng afe elave lo equy euns. hs mgh also be ndcaed as a fom of negave-feedback adng efeng o buyng pas loses and sellng pas nnes see e.g. Lakonshok e al. (992). hs fom of adng s commonly a pa of he agumen ha nsuonal nvesos sablze asse pces. By conas e use fee floa o ndcae a passve nvesmen saegy n hch penson funds allo he equy allocaon o df h make developmens. 6 Fnally as measues he skll of he asse manage and s defned as he coelaon beeen hs foecass on nvesmen euns and he acual oucomes. he numbe of ndependen nvesmen decsons s fou f he penson fund makes quaely make mng decsons. o geneae a make mng nfomaon ao of 0.5 eques n ha case an nfomaon coeffcen of 0.25 hch s consdeed exemely hgh. I ould eque he asse manage o foecas he decon of he sock make coecly 63 ou of 00 mes and adjus hs pofolo lkese. heefoe he poenal added value of make mng s lmed. In addon such a saegy ould nvolve (subsanal) ansacon coss. 6 Penson funds can ebalance connuously heeby ensung ha he asse allocaon alays maches he saegc asse allocaon. Hoeve penson funds ae knon o use ebalancng saeges hch have some fee

5 5 menoned above make mng efes o a empoay hghe o loe eghng of eques (o ohe asse classes) elave o he penson fund s saegc asse allocaon movaed by sho-em eun expecaons. Noe ha hee no equy ades ae made s dffcul o dsngush beeen fee floa (passve managemen) and make mng (acve managemen) as allong he asse allocaon o df could be seen as an acve nvesmen decson. A numbe of sudes sho ha saegc asse allocaon domnaes pofolo pefomance. In pacula saegc asse allocaon s shon o explan moe han 90 pecen of he vaably n penson fund euns ove me hle he addonal vaaon explaned by make mng s less han 5 pecen (Blake Lehmann and mmemann 999; Bnson e al ; Ibboson and Kaplan 2000). Moeove n lne h he effcen make heoy evdence shos ha penson funds ae unsuccessful n explong make mng o geneae excess euns. In pacula make mng s shon o cause an aveage loss of bass pons pe yea (Blake e al. 999; Bnson e al ; Danel e al. 997). Whle a numbe of empcal sudes examne he mpac of nvesmen polcy on euns 7 vey fe papes nvesgae he mpac of make developmens on nvesmen polcy. Blake e al. (999) and Kakes (2006) epo a negave coelaon beeen asse class euns and ne cash flos o he coespondng asse class hch pons o ebalancng. Hoeve Blake e al. (999) also fnd ha he asse allocaon fo UK penson funds dfs oad asse classes ha pefomed elavely ell n lne h a fee-floa saegy. Appaenly UK penson funds only paly ebalanced he nvesmens n esponse o dffeen euns acoss asse caegoes. Hence he degee of ebalancng vesus fee floa n penson fund asse allocaon emans an open queson. hs acle uses quaely daa fom Duch penson funds ove 999:I 2006:IV. Alhough hs peod s elavely sho conans a sgnfcan sock make bubble as ell as a bus. Fgue 2 pesens a peve of he empcal esuls depcng he saegc and he acual equy allocaon fo Duch penson funds as ell as he MSCI Wold Index. hee paens sand ou fom hs fgue. Fs he acual equy allocaon ends o have a paen smla o he MSCI Wold Index bu h some eveson o he saegc asse allocaon. Geneally acual equy allocaon nceases hen he sock floa componen. xamples nclude calenda ebalancng heeby penson funds ebalance he pofolo back o s saegc eghs a egula nevals and band ebalancng heeby penson funds ceae bands aound each asse class and ebalance he pofolo as soon as one asse class beaches s band. 7 he leaue nvesgang he effecveness of sock pckng and make mng n mpovng nvesmen pefomance s exensve. Mos sudes focus on US muual funds and fnd ha fund manages ae no able o explo selecvy and mng o geneae excess euns (e.g. Fama (972) Henksson and Meon (98) Kon and Jen (979) and Kon (983)). Agne e al. (2003) epo ha equy allocaons of pacpans n 40(k) plans ae posvely elaed o he pevous day s equy eun (feedback adng). Hoeve no sgnfcan coelaon s found beeen changes n equy allocaons and euns ove he follong hee days suggesng he absence of make-mng ables.

6 6 make goes up and vce vesa. he man explanaon fo hs paen s ha penson funds end o ebalance he asse allocaon only paly n esponse o changes n he value of he equy pofolo. Fgue 2: Sock make euns and equy nvesmens (999:I 2006:IV) :Q 999:Q3 2000:Q 2000:Q3 200:Q 200:Q3 2002:Q 2002:Q3 quy allocaon (%). 2003:Q 2003:Q3 2004:Q 2004:Q3 2005:Q 2005:Q3 2006:Q 2006:Q MSCI Wold ndex. 60 Saegc allocaon (%) Acual allocaon (%) MSCI Wold ndex Second Fgue 2 pons o neacon beeen sock make pefomance and saegc asse allocaon. he saegc equy allocaon appeas o follo he pefomance of he equy make alhough only gadually and h a me lag. Follong he sock make boom n he second half of he 990s he saegc equy allocaon nceased unl he end of 200 bu deceased fom 2002 o 2003 n esponse o he fall of he sock make ha saed n A possble explanaon s ha penson funds adjus he nvesmen polces based on ecen sock make pefomance. Posve excess euns ncease he penson fund s buffe so ha as a consequence egulaoy ules also allo fo a hghe popoon of he moe sky equy nvesmens. Appaenly penson funds make use of hs oppouny and adjus he saegc asse allocaon accodngly. hd he fgue suggess ha penson funds may have los money fom make mng ove he busness cycle. hey seem o have gadually nceased he equy allocaon unl he donun of he sock make as ell unde ay confonng hem h elavely lage losses. Convesely penson funds dd no sgnfcanly ncease he equy allocaon pofolo nvesmens o eap he full benef of he subsequen upad sock make end.

7 7 he sucue of hs acle s as follos. Secon 2 pesens he daa used n he analyses. Secon 3 nvesgaes he nfluence of make movemens on asse allocaon heeas ebalancng s moe closely examned n Secon 4. he nex secon analyses he elaonshp beeen sock make euns and saegc asse allocaon. Fnally he las secon summazes and concludes. 2 Descpon of he daa We use a dealed daase h quaely nfomaon on all Duch penson funds fo he 999:I 2006:VI peod. he daa s fom De Nedelandsche Bank esponsble fo he pudenal supevson of he 748 penson funds and he egulaoy complance. Fo each penson fund daa s avalable on saegc asse allocaon asse sales and puchases he make value of nvesmens n dffeen asse classes and he me-eghed euns. We use self-epoed euns as ell as he MSCI Wold oal eun ndex denomnaed n euos o assess he mpac of equy euns on acual and saegc equy allocaon. he sample s an unbalanced panel as no all penson funds epoed daa fo he ene sample peod due o ne enans meges emnaons and epong falues. Snce ou am s o sudy asse allocaon ove me e exclude penson funds h less han o yeas of daa. Fnally e exclude nconssen obsevaons and obsevaons h clea epong eos. Ou fnal sample ncludes daa on 748 penson funds fom 999:I 2006:IV epesenng aound 85% pecen of oal penson fund asses n he Nehelands. able 2 pesens summay sascs on he nvesmen pofolos of penson funds n ou sample. he sze of penson funds n he sample s hugely dvegen: he smalles penson funds have asses oh less han mllon hle he lages fund has asses of moe han 200 bllon. he aveage and medan szes of penson fund asses equal 799 mllon and 53 mllon especvely. We dsngush beeen sze classes and ypes of penson funds and beeen ypes of penson plans. Small funds end o nves elavely less n equy compaed o lage funds and moe n bonds eflecng loe sk appee. Alhough lage n numbe (70% of he sample) small funds admnse only a mno shae (less han 3%) of all penson fund nvesmens.

8 8 able 2: Invesmens acoss sze classes and penson fund ypes (999:I 2006:IV) Numbe Aveage Max mn Aveage acual equy Max mn Sze classes based on ofaveage oal bond equy nvesmens saegc equy oal nvesmens penson nvesmens nvesmens nvesmens ove me allocaon oveinvesmen (mln euo) funds (mln euo) (%) (%) (%) me (%) gap (%) a () (2) (3) (4) (5) (6) (7) 0-00 (Small) (Medum) >000 (Lage) oal/aveage ype of penson fund b c Indusy (all) Compulsoy Non-compulsoy Company Pofessonal goup Plan ype c DB DC Noe: All sascs ae aveages eghed by oal nvesmens excep fo he fs o columns (Numbe of penson funds and Aveage oal nvesmens). a Invesmen gap s he absolue dffeence beeen he saegc equy allocaon and he acual pecenage of equy pofolo nvesmens; b en penson funds belong o ohe caegoes; c Fo some penson funds ype of penson fund o domnan plan ype ae unknon. Ou sample ncludes 63 company funds 95 ndusy-de funds and 0 pofessonal goup funds. 8 Compulsoy ndusy funds ae lages n ems of nvesmens. All penson fund caegoes nves beeen 4 and 45 pecen n equy. Company funds and pofessonal goup funds nves elavely moe n bonds han ohe ypes of funds eflecng he songe sk aveson. Indusy funds nves subsanally moe n eal esae. On aveage defned benef (DB) funds have hghe equy and loe bond nvesmens han defned conbuon (DC) funds suggesng ha DB funds may ake hghe sks snce hey can benef fom negeneaonal sk shang. Columns 5 and 6 ndcae ho especvely he acual and saegc equy allocaon vay ove me. Fo he aveage penson fund he ange of he acual equy allocaon s 6% and ha of he saegc equy allocaon s 3%. hus boh acual and saegc equy allocaon move sgnfcanly ove me. he las column shos ha he dffeence beeen saegc and acual equy allocaon s on aveage 0.8 pecenage pon. 8 Company funds povde penson plans o he employees of he sponso company. hey ae sepaae legal enes bu ae un by he sponso company and employee epesenaves. Indusy funds povde penson plans fo employees okng n an ndusy. Such penson plans ae based on a collecve labo ageemen beeen an ndusy s companes and he labo unons epesenng he employees n hs ndusy. Fnally pofessonal goup funds offe penson schemes o specfc pofessonal goups (e.g. geneal pacones publc noaes).

9 9 able 3 shos ha he saegc and acual equy allocaon dffes sgnfcanly acoss penson funds. A small majoy of funds nves pecen of he asses n eques. A quae of he funds nves moe han 40 pecen n eques hle aound one-ffh of he funds nves less han 20 pecen n eques. able 3: Fequency dsbuon of equy allocaon acoss penson funds (999:I 2006:IV; n %) Invesmen-n-equy classes Fequency dsbuon of penson funds based on he equy allocaon saegy acual equy allocaon oal Relave sock-make euns and sho-em changes n equy allocaon o sa ou empcal analyss hs secon examnes he sho-em mpac of sock make pefomance on equy allocaon. Ove me acual equy allocaon may change ehe () due o excess euns on eques compaed o ohe asse classes (fee floang) o () due o ne puchases o ne sales of eques (ebalancng and make mng). o nvesgae he mpac of elave sock make euns on penson funds equy allocaon e esmae he follong equaon: ( j j ) γ Polcy δsze λ fundng k = α Σ j 0β j ε = () he dependen vaable s he acual pecenage of he pofolo nvesed n eques of penson fund ( = N) a quae ( = ). he vaable ( ) s used o measue excess sock make euns compaed o ohe nvesmen caegoes on a quaely bass. Fo sock make eun ( ) e use ehe he eun on he MSCI Wold equy ndex o he penson funds self-epoed equy pefomance. Fo he aveage eun on he penson fund pofolo s ohe asse caegoes ( ) e mulply he saegc asse allocaon of fou key asse classes by ehe he penson funds' on epoed euns o epesenave boad make ndexes. 9 Agan he alenave s o use he penson funds self-epoed pefomance on he especve asse classes. We consde o vaans of quaon 9 We consde fve nvesmen caegoes: eques bonds eal esae money make nsumens and ohe asses. Fo bonds e use he JP Mogan MU bond ndex fo eal esae e use he FS PRA Nehelands eal esae ndex and fo money-make nvesmens e use he 3-monh ubo nees ae. We assume ha he ffh caegoy ohe asses s popoonally nvesed n he pevous fou nvesmen caegoes (o has a smla eun). We calculae excess euns as follos: excess eun = eun MSCI [(eun on bonds * bond nvesmens eun on eal esae * eal esae nvesmens 3-monhs ubo * money make nvesmens) / (bond nvesmens eal esae nvesmens money make nvesmens)].

10 0 (). he base model s hou lagged sock make euns (k = 0) heeas alenavely e nclude excess sock make euns h me lags (k = 5) o nvesgae he nfluence of pas euns on penson funds equy nvesmens. he saegc equy allocaon (Polcy) also expessed as a pecenage s ncluded o conol fo penson fund nvesmen polcy. Sze hch s measued as he logahm of he oal nvesmen pofolo conols fo he endency of lage funds o nves elavely moe n eques. Fundng calculaed as oal nvesmens / dscouned penson lables s ncluded because funds h a hghe buffe ae alloed o nves moe n eques. Polcy Sze and Fundng ae ncluded h one me lag o avod endogeney poblems and snce may ake some me befoe changes n hese vaables lead o changes n he equy pofolo nvesmen. As saed befoe he panel s unbalanced hch mples ha he numbe of obsevaons vaes acoss penson funds. 3. mpcal esuls of he mpac of sock euns on acual equy allocaon able 4 pesens esmaes of he mpac of sho-em excess sock euns on he pecenage of equy pofolo nvesmens usng quaon (). he measue of excess sock euns n hs able s based on he penson fund s self-epoed asse euns. A one-pecenage pon oupefomance of he penson funds eques leads o a sgnfcan ncease n equy allocaon of 0.2 pecenage pon n he subsequen quae (fs column). he second column shos ha excess equy euns also have a (hghly) sgnfcan mpac on he equy allocaon up o fve quaes lae. he mpac deceases ove me ndcang ha penson funds ebalance gadually o nfequenly. If a penson fund nvess 40 pecen n equy a one pecen se of sock pces ould mply an ncease of he egh of socks by 0.24 pecenage pon (beng 40.4/00.4 mnus 40/00) ha s as long as no adjusmens ae made. In hs example he obseved 0.2 pecenage pon effec of excess euns on penson funds equy mples ha only half he excess s ebalanced and ha he ohe half of he equy egh moves n andem h sock pces. able 4: smaes of he penson funds equy nvesmens model (999:II 2006:IV) All funds Small funds Medum szed funds Lage funds () (2) (3) (4) (5) xcess eun 0.8 *** 0.03 *** *** 0.09 *** 0.25 *** Idem lagged quae *** *** *** *** Idem lagged 2 quaes *** *** *** *** Idem lagged 3 quaes 0.03 *** *** *** *** Idem lagged 4 quaes *** *** *** *** Idem lagged 5 quaes 0.08 *** 0.04 ** *** ** Invesmen polcy (-) *** 0.90 *** 0.93 *** *** *** Sze (-) 0.00 *** 0.00 ** *** *** *** Fundng ao (-) *** 0.06 *** 0.0 *** *** 0.0 *** Inecep *** *** *** ** Numbe of obsevaons R 2 adjused

11 Noes: *** ** and * denoe sgnfcance a he % 5% and 0% sgnfcance levels especvely. he sandad eos have been coeced fo possble heeoskedascy o lack of nomaly usng he Hube-Whe sandch esmaos. smaes fo excess euns ae based on daa epoed by penson funds. able 4 eveals also ha a one pecenage pon ncease n he saegc equy allocaon causes a sgnfcan se of aound 0.90 pecenage pon n acual equy pofolo nvesmens n he nex peod. As one ould expec penson fund nvesmen manages adjus he equy pofolo nvesmens almos fully n esponse o changes n he saegc equy allocaon. he posve sgn fo he sze of nvesmens affms ha lage funds nves elavely moe n eques (see also able ) excep hn he medum-szed funds class hee he sgn becomes negave. A possble explanaon s ha lage penson funds end o be less sk avese han small penson funds hch also holds hn he classes of small and lage funds. Fnally n lne h expecaons he fundng ao has a hghly sgnfcan posve coeffcen ndcang ha funds h lage buffes nves moe n eques. As eques ae moe sky egulaon eques lage buffes fo hs asse class. If e consde he nvesmen behavo acoss sze classes (las hee columns) hee sze classes ae defned as n able 2 e obseve ha he mpac of excess sock make euns on equy allocaon nceases h he penson fund sze boh mmedaely and n he long un. Appaenly lage funds allo moe fee floang heeas smalle funds ebalance moe. In lne h hs esul lage funds eac less o changes n he nvesmen polcy compaed o smalle funds. 4 xcess sock make euns and ebalancng he posve mpac of excess equy euns on equy allocaon n he pevous secon may be (paly) due o mpefec ebalancng by penson funds. xcess equy pefomance ll auomacally lead o changes n equy allocaon f penson funds do no acvely ebalance he nvesmen pofolos fully. hs secon pesens an empcal ebalancng model hch s used o esmae o ha exen penson funds ebalance ha s e-adjus he asse allocaon n esponse o excess equy euns. 0 hs model s deved as follos sang fom he defnon of he acual equy allocaon: / A = (2) hee epesens he equy nvesmens of penson fund a me and A sands fo oal asses. akng fs dffeences of quaon (2) e oban: 0 An alenave appoach o measue ebalancng based on penson funds equy sales and puchases s pesened n he appendx.

12 2 = A A ) ( ) ( = A A ) ( ) ( ) ( ) ( = ) ( ) ( = (3) hee s sho fo Ne Class Flos conveed no ne nvesmens as a facon of oal nvesmens fo ne equy nvesmens also as a facon of equy nvesmens fo he eun on eques ove he las quae and fo he eun on oal asses (all fo fund and quae ). Dvdng boh sdes by - esuls n: = (4) hs equaon explans he pecenage change n equy allocaon by: () excess equy euns and () ne cash flos o eques hee boh vaables ae scaled by he change n he oal pofolo sze. he fs gh-hand em s exogenous snce excess euns ae deemned by make developmens and ne cash flos no he penson fund ae based on (pevously made) decsons by employes and employees ahe han on equy allocaon. Gven he small sze of penson fund nvesmens elave o oal sock make capalzaon e can safely assume ha changes n equy allocaon do no affec sock make euns. he second gh-hand em hoeve s endogenous. Whle ne cash flos o equy nvesmens decly nfluence he equy allocaon of penson funds he evese can also be ue: changes n he equy allocaon may say penson funds o adjus he ne cash flos o equy nvesmens. hus hee s muual causaly beeen changes n equy allocaon and ne cash flos o equy nvesmens. o esmae he mpac of excess equy euns on equy allocaon e apply he above decomposon gnong he endogenous second gh hand em. hs esuls n he follong empcal egesson model: Polcy Polcy ε γ β α Δ = (5) he pecenage change o goh n he saegc equy allocaon (Polcy) s ncluded o conol fo changes n nvesmen polcy. hs vaable s ncluded h a me lag of one quae snce may ake some me befoe changes n polcy lead o adjusmens n he acual equy pofolo nvesmens.

13 3 In quaon (5) β 2 esmaes he degee of fee floa o make mng so ha -β 2 assesses he ebalancng pecenage. As an alenave model e spl he excess equy eun vaable no posve and negave equy euns. hs allos us o obseve possble asymmec effecs n esponse o changes n excess equy euns. 4. mpcal esuls of ebalancng able 5 pesens he esmaed mpac of excess equy euns on equy allocaon. he esuls sho ha penson funds ebalance on aveage aound 39 pecen of excess equy euns leavng 6 pecen fo fee floang. hus 6 pecen of excess equy euns anslae no nceases of he equy allocaon n he nex peod. hs s oughly n lne h ha e have obseved n able 4. Column (2) shos ha penson funds ebalance dffeenly n esponse o posve and negave equy euns. Only 3 pecen of posve equy euns ae ebalanced agans 49 pecen of negave equy euns. Appaenly heeas penson funds do no auomacally sell eques n bull makes hey do end o buy addonal eques n bea makes. In lne h expecaons changes n polcy affec he acual allocaon posvely (sgnfcan a he % sgnfcance level) h a lag of one quae. able 5: smaes of he equy allocaon model: ebalancng vesus fee floa (999:II 2006:IV) All funds Small funds Medum szed Lage funds funds () (2) (3) (4) (5) (6) (7) (8) xcess equy euns Posve excess equy euns Negave excess equy euns Change n polcy (-) Inecep Numbe of obsevaons R 2 adjused Noes: All symmec and asymmec excess equy euns effecs ae sgnfcan a he % sgnfcance level. he sandad eos have been coeced fo possble heeoskedascy o lack of nomaly usng he Hube-Whe sandch esmaos. smaes fo excess euns ae based on daa epoed by penson funds. Columns (3) o (8) pesen he model esmaes fo he vaous sze classes. In lne h he esuls of Secon 3. e obseve ha n he symmec model vaan lage funds a 32 pecen ebalance less han he small and medum-szed funds (aound 40 pecen). Consequenly lage funds leave 68 pecen fo fee floang. Changes n he one quae lagged saegc equy allocaon (Polcy) affec acual allocaon sgnfcanly (a he % sgnfcance level) fo he small funds only. If e un o he asymmec effecs on excess equy euns e obseve ha he posve effecs ncease sgnfcanly h penson fund sze hle he negave effecs ae smla acoss he sze classes. he posve euns coeffcen fo he lages funds s a.2 even above ndcang ha lage funds nves addonal funds n eques n esponse o posve excess euns n he las monh. hs suggess ha excess equy euns ae peceved by lage penson funds o povde a posve sgnal fo fuue

14 4 euns leadng penson funds o ncease he sakes. hs s n lne h esuls n able 4 hch ndcae ha lage funds espond moe songly o excess equy euns han small ones. A possble explanaon s ha manages of lage funds have moe feedom o use make mng saeges n esponse o make developmens. Que emakable e obseve ha he saegc equy allocaon (alhough nceasng fo small and medum-szed penson funds) s no nceasng fo lage penson funds e.g. compae 999 o hs holds also fo he acual equy allocaon. Hence he oveshoong fo lage funds as e have esmaed n ou pape s appaenly no due o an ncease n he saegc asse allocaon ove me. Fgue 3 pesens he asymmec elaon beeen excess equy euns and ebalancng dscussed above. If penson funds used a fee floa saegy and dd no ebalance a all excess equy euns ould go n full o popoonae nceases n equy allocaon. hs s epesened by he dagonal lne. Insead h full ebalancng excess equy euns ould have no mpac on equy allocaon maked off on he x-axs. he cuvaue dvdng he fee floa and ebalancng aeas eflecs he acual ebalancng behavo of Duch penson funds. Skngly ebalancng by penson funds depends on boh he sgn and sze of excess equy euns. Small posve equy euns (of aound 0-5%) ae no ebalanced a all bu he degee of ebalancng nceases h he sze of excess equy euns. Insead small negave euns (of aound 0 o -0%) ae ebalanced fo he lages pa bu he degee of ebalancng deceases h he sze of negave excess euns. o esmae hs fgue e adjused quaon 5 by addng hee addonal ems: squaed excess equy euns and excess and squaed equy euns mulpled h 0- dummes ndcang posve and negave euns.

15 5 Fgue 3: Reacon of penson funds o excess equy euns: ebalancng and fee floa Rebalancng Changes n equy allocaon (%) 0 Fee floa Fee floa -0 Rebalancng Changes n equy pces (%) 5 xcess sock make euns and medum-em changes n saegc equy allocaon he pevous o secons descbed he effecs of excess equy euns on acual equy allocaon. hs secon nvesgaes he mpac of (annual) sock make pefomance (a - a ) on penson funds saegc equy allocaon (Polcy). heefoe e esmae he follong equaon: ( a a ) γ 3Polcy δ 3Sze Polcy (6) = α 3 β 3 ε he excess sock make pefomance has been aken on an annual bass ndcaed by (a a ) hee a efes o annual. We assume ha he penson fund usees base he polcy on longe-em measues of pefomance as also efleced by he empcal esuls. As above Sze conols fo he endency of lage funds o nves elavely moe n equy pofolos. We also nclude a lag of he dependen vaable Polcy as e expec only gadual changes n polcy ove me. Hence he equaon descbes he quaely adjusmens n polcy mpcal esuls of he mpac of sock make euns on saegc equy allocaon able 6 shos he mpac of excess sock make euns on saegc equy allocaon. he nvesmen polcy s adjused sgnfcanly n esponse o changes n equy euns especve of hehe hey ae measued by he MSCI o by he acual nvesmen euns eaned by penson funds. hs shos 2 An alenave model h fs dffeences of Polcy as he dependen vaable nsead of gadual adjusmen leads o smla esmaon esuls (no epoed hee).

16 6 ha nvesmen polcy s no consan ove me bu o some exen follos make developmens. he coeffcen of he lagged dependen vaable 0.97 ndcaes ha sloly he saegc equy allocaon eacs only o a small exend o changes n he quaely euns. On aveage 97 pecen of he equy nvesmen polcy s deemned by he pevous quae s nvesmen polcy heeas make developmens accoun fo he emanng 3 pecen. hese make developmens capued by he yealy excess eun have a small bu vey sgnfcan mpac boh based on he MSCI and on he acual equy eun of he penson fund. he fnal mpac on equy nvesmen polcy ove me s 0.25 (= /( 0.972)). able 6: smaes of he saegc equy allocaon model (999:II 2006:IV) All funds Small funds Medum- Lage funds szed funds () (2) (3) (4) (5) quy nvesmen polcy (-) 0.972*** 0.972*** 0.970*** 0.97 *** 0.978*** Yealy excess eun MSCI 0.007*** Yealy excess penson fund s equy eun *** *** *** * Sze (-) 0.00*** 0.00*** Inecep 0.00*** 0.003*** Numbe of obsevaons R 2 adjused Noes: *** ** and * denoe sgnfcance a he % 5% and 0% sgnfcance levels especvely. he sandad eos have been coeced fo heeoskedascy usng he Hube-Whe sandch esmaos. smaes fo excess euns ae based on daa epoed by penson funds. he sze effec s also small bu sgnfcan. Whle hs equaon shos ho nvesmen polcy s nfluenced by make developmens does no povde a model of he undelyng nvesmen polcy decsons hch ae geneally based on asse lably managemen sudes. he esuls acoss penson fund sze classes ae que smla. We used hee alenave appoaches o check he obusness of ou esuls. 3 Fs e esmaed all equaons employng he alenave measue of excess equy euns based on make ndces. Resuls ee vey close o he epoed esmaes based on self-epoed euns ndcang ha on aveage acual asse euns folloed he same paen as ndex euns. Second e also an egessons fo a balanced sample of a subse of 382 penson funds ha epoed a leas seven yeas of daa. he egesson esuls ee smla o hose epoed n ables 4-7 suggesng ha suvvoshp bas s no a sgnfcan ssue. hd e e-esmaed all egessons usng fxed effecs fo penson funds and yeas. he Hausman es ejeced andom effecs. he esuls ae agan faly smla excep fo able 6. 4 Oveall hese esuls confm ha ou oucomes ae obus. 3 he ables of alenave esmaes have no been epoed hee bu ae avalable upon eques by he auhos. 4 In able 6 he coeffcens levels of sgnfcance ae subsanally loe. Appaenly he penson funds fxed effecs pcked up a pa of he vaaon n he explanaoy vaables.

17 7 6 Conclusons hs acle fnds ha sock make pefomance nfluences he asse allocaon of penson funds n o ays. In he sho em he oupefomance of eques ove bonds and ohe nvesmen caegoes auomacally esuls n hghe equy allocaon (and vce vesa) as penson funds do no connuously ebalance he asse allocaon. ach quae penson funds ebalance on aveage aound 39 pecen of excess equy euns. he emanng 6 pecen leads o hghe o loe equy allocaon as a esul of fee floang hch ae fuhe ebalanced n subsequen quaes. In he medum em oupefomance of eques nduces penson funds o ncease he saegc equy allocaon (and vce vesa). Oveall ou esmaes ndcae ha he nvesmen polcy of penson funds s paally dven by he (cyclcal) pefomance of he sock make. Appaenly penson funds suffe fom myopc nvesmen behavo: hey end o base nvesmen decsons on ecen sock make pefomance ahe han on long em ends. We also fnd ha penson funds eac asymmecally o sock make shocks. quy eallocaon s hghe afe undepefomance of equy nvesmens hen afe oupefomance. In pacula only 3 pecen of posve excess equy euns s ebalanced hle 49 pecen of negave shocks esuls n ebalancng. he fome can be ndcaed as a buy on he dp saegy and he lae as a he end s you fend appoach. hus penson funds lm any declne n equy allocaon n esponse o undepefomance bu hey allo hghe exposues o eques hen hese oupefom ohe nvesmens. Appaenly equy pofolo manages ae able o convnce penson funds boh o eplensh he funds n bea makes (o pof fom lo asse pces) and o ncease he equy allocaon n bull makes (o ake advanage of sng makes). Lage funds nvesmen behavo s dffeen fom ha of small funds. hey nves moe n equy and he equy allocaon s affeced much moe songly by acual equy euns. he lae mples ha lage funds ebalance less possbly because manages enjoy moe feedom n mplemenng make mng saeges. We fnd asymmec effecs on excess equy euns hee he posve effecs ncease sgnfcanly h penson fund sze. he coeffcen of posve euns of he lages funds s n fac sgnfcanly above eflecng oveshoong of fee floang o posve feedback adng. A possble explanaon s ha manages of lage funds have moe feedom o espond o make developmens and paculaly n bull makes demonsae gea sk oleance. Refeences Agne Jule Pelug Balduzz and Annka Sundén 2003 Pofolo Choce and adng n a Lage 40(k) Plan Amecan conomc Reve 93 ():

18 8 Babes Ncholas 2000 Invesng fo he long un hen euns ae pedcable Jounal of Fnance 55 (): Bkke Jacob A. and Jan de Deu 2009 Opeang coss of penson funds: he mpac of scale govenance and plan desgn Jounal of Penson conomcs and Fnance Blake Davd Buce N. Lehmann and Allan mmemann 999 Asse allocaon dynamcs and penson fund pefomance Jounal of Busness 72 (4): Bnson Gay P. Randolph Hood and Glbe L. Beeboe 986 Deemnans of pofolo pefomance Fnancal Analyss Jounal 42 (4): Bnson Gay P. Ban D. Snge and Glbe L. Beeboe 99 Deemnans of pofolo pefomance II: An updae Fnancal Analyss Jounal 47 (3): Boedes Dk W.G.A. he valuaon of condonal penson lables and guaanees unde sponso vulneably DNB Wokng Pape no. 82 De Nedelandsche Bank Amsedam. Campbell John Y. and Lus M. Vcea (2002) Saegc Asse Allocaon: Pofolo Choce fo Long- em Invesos Oxfod Unvesy Pess. Danel Ken Mak Gnbla Shedan man and Russ Wemes 997 Measung muual fund pefomance h chaacesc-based benchmaks Jounal of Fnance 52 (3): Fama ugene F. 972 Componens of nvesmen pefomance Jounal of Fnance 27 (3): Gnbla Mak and Shedan man 993 Pefomance measuemen hou benchmaks: An xamnaon of Muual Fund Reuns Jounal of Busness 66 (): Henksson Roy D. and Robe C. Meon 98 On make mng and nvesmen pefomance. II. Sascal pocedues fo evaluang foecasng sklls Jounal of Busness 54 (4): Ibboson Roge G. and Paul D. Kaplan 2000 Does asse allocaon polcy explan o 00 pecen of pefomance? Fnancal Analyss Jounal 56: Kakes Jan 2006 Fnancal behavou of Duch penson funds: a dsaggegaed appoach DNB Wokng Pape n. 08 De Nedelandsche Bank Amsedam. Kon Sanley J. 983 he Make-mng pefomance of muual fund manages Jounal of Busness 56 (3): Kon Sanley J. and Fank C. Jen 979 he nvesmen pefomance of muual funds: An empcal nvesgaon of mng selecvy and make effcency Jounal of Busness 52 (2): Lakonshok Josef Ande Schlefe and Robe W. Vshny 992 he mpac of nsuonal adng on sock pces Jounal of Fnancal conomcs 32: Páso Luboš and Robe F. Sambaugh 200 he equy pemum and sucual beaks Jounal of Fnance 56 (4): Shefn Hesh and Me Saman 2000 Behavoal Pofolo heoy he Jounal of Fnancal and Quanave Analyss 35 (2): 27-5.

19 9 APPNDIX: PNSION FUNDS QUIY PURCHASS AND SALS An alenave pocedue o esmae ebalancng s o use he puchases and sales of equy nvesmens as he dependen vaable. quaon (7) esmaes he mpac of excess equy euns on ne equy puchases o sales. quy puchases = 4 β 4 ) γ 4ΔPolcy δ 4 ( Polcy ) λ fundng α ( ε (7) quy puchases s defned as ne equy puchases () o sales (-) of fund a quae as a pecenage of oal equy. he explanaoy vaables ae he same as befoe: ( ) measues excess sock make euns compaed o ohe nvesmen caegoes s he pecenage of penson fund equy nvesmens hle Polcy s he saegc equy allocaon. Addonally e consde asymmec effecs of excess equy euns on equy ansacons. We conol fo changes n he saegc equy allocaon (ΔPolcy)fo dffeences beeen he saegc equy allocaon (Polcy ) and acual equy nvesmens (he nvesmen gap ) and fo he fundng ao all lagged one quae. able 7 pesens evdence on ebalancng as he pecenage of equy pofolo puchases and sales ae sgnfcanly affeced by excess equy euns. Negave equy euns ae he man foce behnd hs phenomenon (see Column 3). he nvesmen gap s also a sgnfcan dve of equy pofolo sales and puchases. Alhough he ebalancng and nvesmen gap effecs ae sgnfcan only a ny poon of he vaaon n equy pofolo sales and puchases s explaned by ou model (see adjused R 2 ). able 7: smaes of he equy puchases and sales model (999:II 2006:IV) All funds Small funds Medumszed funds Lage funds () (2) (3) (4) (5) (6) xcess equy euns -0.9*** -0.9*** -0.2*** -0.20*** -0.3*** Posve excess equy euns -0.07** Negave excess equy euns -0.23*** Change n saegc equy allocaon (-) 0.0** 0.0*** ** Invesmen gap (-) 0.34*** 0.33*** 0.40*** 0.32*** 0.24*** Fundng ao (-) -0.03*** -0.02*** -0.02*** -0.02*** -0.02*** -0.0 Inecep 0.05*** 0.04*** 0.04*** 0.05*** 0.04*** 0.02*** Numbe of obsevaons R 2 adjused Noes: *** ** and * denoe sgnfcance a he % 5% and 0% sgnfcance levels especvely. he sandad eos have been coeced fo heeoskedascy usng he Hube-Whe sandch esmaos. smaes fo excess euns ae based on daa epoed by penson funds.

20 20 unng o he sze class esmaes e fnd less ebalancng behavo of he lage funds compaed o small funds. hs s fuhe emphaszed by he obsevaon ha lage funds also eac less han small funds o changes n he polcy and nvesmen gap.