The Return Expectations of Institutional Investors

50 Pages Posted: 28 Dec 2017 Last revised: 28 Feb 2018

Aleksandar Andonov

Erasmus University Rotterdam, Erasmus School of Economics

Joshua D. Rauh

Stanford Graduate School of Business; Hoover Institution; National Bureau of Economic Research (NBER)

Date Written: February 27, 2018


Institutional investors rely on past performance in setting future return expectations, and these extrapolative expectations affect their target asset allocations. Drawing on newly-required disclosures for U.S. public pension funds, a group that manages approximately $4 trillion of assets, we find that cross-sectional variation in past returns contributes substantial power for explaining real portfolio expected returns and expected risk premia in individual asset classes. Pension fund past performance affects real return assumptions across all risky asset classes, including in public equity where the relative performance of institutional investors is not persistent. In private equity, the extrapolation of past performance is driven by stale investments. State and local governments that are more fiscally stressed by higher unfunded pension liabilities assume higher portfolio returns, both through higher inflation assumptions and higher real returns, but this factor does not attenuate the extrapolative effects. Expected risk premia in public equity, private equity, and real assets are all correlated with funds’ target asset allocation. Realized past returns affect the target asset allocation through an extrapolation channel.

Keywords: Institutional investors, return expectations, asset allocation, portfolio choice, return extrapolation

JEL Classification: G02, G11, G23, G28, H75, D83, D84

Suggested Citation

Andonov, Aleksandar and Rauh, Joshua D., The Return Expectations of Institutional Investors (February 27, 2018). Stanford University Graduate School of Business Research Paper No. 18-5. Available at SSRN: or

Aleksandar Andonov

Erasmus University Rotterdam, Erasmus School of Economics ( email )

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

Joshua D. Rauh (Contact Author)

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

Hoover Institution ( email )

Stanford, CA 94305-6010
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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