Do pension funds beat style-matching passive funds?

Abstract

Pension funds manage approximately 45% of US capital market equity capitalization, about US$7.1 trillion, and manage 55% of the Australian one, about US$0.65 trillion. Their yearly fee charges exceed US$100 billion. We ask whether US and Australian investors would earn, on average, higher net returns by investing in equity retirement funds than by investing in publicly traded passive index funds. We use twenty years of Morningstar data covering 8% and 23% of total pension assets in the US and Australia, respectively. We perform Sharpe Style analysis replicating pension funds styles by using Treasury assets and traded index funds. We find that both US and Australian investors who invest in actively managed equity pension funds would earn no higher net returns than those generated from the passive style-matching portfolios. Also, we do not find risk-adjusted abnormal returns of US equity pension funds, while we do find negative risk-adjusted abnormal returns of Australian equity pension funds, after controlling for risk using unconditional and conditional sensitivities to the Fama, French, and Carhart factors. Because ETFs (exchange-traded funds) were introduced relatively recently, sufficient data is not available for this study; ETF investments, with typically lower expense ratios, would have enhanced our results. As most retirement savings are compulsory and regulated, there are policy implications to governments, public and private employers, and pension savers. In particular, facilitating investing in traded passive index funds, or facilitating switching from actively managed pension funds to traded passive index funds would increase societal welfare by increasing retirement contribution values and might free significant human capital to productive ventures.