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Can Large Pension Funds Beat the Market? Asset Allocation, Market Timing, Security Selection and the Limits of Liquidity

48 Pages Posted: 14 Jul 2011 Last revised: 15 Nov 2012

Aleksandar Andonov

Erasmus University Rotterdam, Erasmus School of Economics

Rob Bauer

Maastricht University

Martijn Cremers

University of Notre Dame

Date Written: October 2012

Abstract

We analyze the three components of active management (asset allocation, market timing and security selection) in the net performance of U.S. pension funds and relate these to fund size and the liquidity of the investments. On average, the funds in our sample have an annual net alpha of 89 basis points that is evenly distributed across the asset allocation, market timing, and security selection components. Stock momentum fully explains the positive alpha in security selection, whereas “time series momentum” drives market timing. While larger pension funds have lower investment costs, this does not lead to better net performance. Rather, all three components of active management exhibit substantial diseconomies of scale directly related to illiquidity. Our results suggest that especially the larger pension funds would have done better if they invested more in passive mandates without frequent rebalancing across asset classes.

Keywords: pension fund performance, asset allocation, market timing, security selection, dis-economies of scale, liquidity.

JEL Classification: G11, G23

Suggested Citation

Andonov, Aleksandar and Bauer, Rob and Cremers, Martijn, Can Large Pension Funds Beat the Market? Asset Allocation, Market Timing, Security Selection and the Limits of Liquidity (October 2012). Available at SSRN: https://ssrn.com/abstract=1885536 or http://dx.doi.org/10.2139/ssrn.1885536

Aleksandar Andonov

Erasmus University Rotterdam, Erasmus School of Economics ( email )

Burgemeester Oudlaan 50
3000 DR Rotterdam, Zuid-Holland 3062PA
Netherlands

Rob Bauer

Maastricht University ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands
+31 43 3883871 (Phone)

K. J. Martijn Cremers (Contact Author)

University of Notre Dame ( email )

P.O. Box 399
Notre Dame, IN 46556-0399
United States

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