Politicians and government-appointed board trustees may not know what is best for pension fund investing—and may even be a cause of poor returns, according to a recent paper.
Public pension board composition had a strong impact on the fund’s private equity performance, wrote Erasmus University’s Aleksandar Antonov, Rice University’s Yael Hochberg, and Stanford University’s Joshua Rauh.
From a study of 210 US public pension funds with more than 13,000 private equity investments from 1990 to 2011, the authors found funds with boards heavily made up of elected officials or members appointed by state representatives underperformed the worst.
Specifically, state-appointed board members were linked to the lowest performance, with a 10-percentage point increase in the proportion of such members resulting in about a 0.9 percentage point drop in annual net internal rate of return (IRR).
And ex officio board members followed suit, with a 10-percentage point rise in their representation leading to a drop in annual net IRR of between 0.53 and 0.67 percentage points.
“This underperformance is related both to investment category allocation and to selection of managers within category,” Antonov, Hochberg, and Rauh continued.
The research revealed funds whose boards housed more state officials and elected plan participants invested more in real estate and fund-of-funds.
These poorly governed funds were also “strongly correlated” with poor investment decisions in private equity including overweighting in small and in-state funds, as well as allocating to inexperienced general partners.
Despite associations to low performance and ill decision-making, these state-appointed and state-ex officio trustees represented 7.6% to 25.4% of board members of 34 studied pension funds on average, the research found.
Trustee background data also showed only 21% of members selected by government executives had asset management experience, and just 10% had any financial experience.
Figures dwindled further for elected officials serving on pension boards, with 18% and 10% with asset management and financial experience, respectively.
Read the full paper, “Pension Fund Board Composition and Investment Performance: Evidence from Private Equity”.
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