Daily Academic Alpha: Pension Fund Returns and High Fees

Daily Academic Alpha: Pension Fund Returns and High Fees

September 10, 2015 Uncategorized

Last updated on January 18th, 2017 at 03:03 pm

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Nobody can deny a simple empirical fact: higher fees are associated with lower returns, on average (Here is a great paper by Ken French on the costs of active investing). This finding, logically, leads investors to focus on low-cost solutions as opposed to high-cost solutions, all else equal.

But do the rules apply to large professional investors?

As the story goes, the large endowments and pensions have an edge due to their scale and access to talent. David Swensen is the classic example. The Swensen story concludes that some large institutional investors should not invest in passive low-cost solutions because they’d be missing out on the “opportunities” that scale and access can provide. Great story, and Swensen is a wonderful anecdote of this working in practice, but the plural of anecdote is data. And what does the data say?

A new working paper from the Maryland Public Policy Institute gives us a brief glimpse at the evidence and find that fees STILL matter, on average.

However, there are some serious caveats to this study, and the results are merely suggestive, and not conclusive.

  1. 5-year sample–hard to say much about anything with 5-years of data
  2. Bullish marketplace–alternatives and other low-beta asset classes will underperform–by construction–in a bullish market.

Bottomline: On average, fees have mattered over the past 5 years for the sample studied, but because of the inherent limits in the study, the debate of passive vs. active will rage on…

Wall Street Fees and Investment Returns for 33 State Pension Funds

The study outlines fees and investment returns for state pension funds. The study concludes that states with the highest fees, as a percent of assets, had the lowest returns. The study shows a passive index mimicking state fund asset allocations provides higher returns. Private equity funds and hedge funds in which the states invested under performed relevant benchmark returns. The study provides some rationales for why the situation continues even though it costs states billions each year in foregone income.

fees and pension funds


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About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray received a PhD, and was a finance professor at Drexel University. Dr. Gray’s interest in entrepreneurship and behavioral finance led him to found Alpha Architect. Dr. Gray has published three books: EMBEDDED: A Marine Corps Adviser Inside the Iraqi Army, QUANTITATIVE VALUE: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, and DIY FINANCIAL ADVISOR: A Simple Solution to Build and Protect Your Wealth. His numerous published works has been highlighted on CBNC, CNN, NPR, Motley Fool, WSJ Market Watch, CFA Institute, Institutional Investor, and CBS News. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.