Sorry Guys, Active Management Does Not Work In Pension Plans
If anyone can beat the markets, it should be pension plan sponsors. They have access to large amounts of pooled money, information, and the best professional money managers that money can buy. Since plan sponsors deal with a large amount of money, they would never hire a manager who had a history of underperformance or mismanagement. Unlike individual investors, pension plan sponsors have direct access to money managers, professional consultants and fund houses. This should help them to prevent making mistakes in the process. Pension plans also have lower fees charged for active management as compared to individual investors.
Academia shows us how "well" active management can work with pension plans. The study, “The Performance of US Pension Plans” covered 716 defined benefit plans and 238 defined contribution plans. Results from the study were astounding. Compared to relative benchmarks, returns of actively managed pension plans were close to 0. The authors of the study concluded “striking similarities in net performance patterns make skill differences highly unlikely" (“Performance” 3). Small plans did no better than big plans. This leads us to conclude that plan sponsors have the inability to identify investment managers who will outperform the market AFTER they are hired. This result did not include trading fees incurred. Thus, all trading activity was counterproductive for these funds.
Another study of pension fund managers, "A Panel Study of U.S. Equity Pension Fund Manager Style Performance,” had the same conclusion. This study covered the performance of 292 pension plans. Again, no correlation found between relative performance in one period and future periods (“Panel” 1). Therefore, return-chasing behaviors DOES NOT deliver positive excess returns. As expected, there was no persistent outperformance over what is randomly expected.
Even with plan sponsors' access to the best managers, consultants, and lower fees, passive funds continue to outperform actively managed funds.
If it is difficult to find investment managers who consistently add value relative to appropriate benchmarks, what makes most individual investors think that they actually will? We will address this question in a future article.
“The Performance of Pension Plans Study” https://wpweb2.tepper.cmu.edu/wfa/wfasecure/upload2009/2009_7.583868E+07_PA_WFAtext.pdf
“A Panel Study of U.S. Equity Pension Fund Manager Style Performance”