Daily Academic Alpha: Pension Fund Returns and High Fees

Daily Academic Alpha: Pension Fund Returns and High Fees

September 10, 2015 Uncategorized
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(Last Updated On: January 18, 2017)

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 earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. 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.


  • IlyaKipnis

    Okay, so can someone explain this to me: why not simply lump in fees with the actual returns, and simply assess track records net of fees? I mean RenTec charges its own employees 5/44 with the Medallion fund, and just keeps killing it every year. Yes, that’s one example, but if investors are happy with net-of-fees returns, doesn’t everyone leave happy?

  • you eat after-tax after-fee returns…so that makes sense.

  • jimhsu

    Not criticizing the value of a low-cost strategy (which should be obvious), but I simply wonder what the results of this study would be if the index period did not correspond to one of the most relentless bull markets in recent history (say, 5 more years back, the period from 2004-2009). Unless, of course, pension systems truly don’t know better.

  • This is major issue with the study–lack of time period and data. But we like to share different perspectives as well.