Performance Measurement in the Pensions Fund Industry By Ian Tonks Xfi Centre for Finance and Investment [joint work with David Blake (CASS), Alan Gregory (Exeter) & Allan Timmermann (San Diego)]

Can Pension Fund Managers Consistently Beat the Market? Myners’ Report (2001): “selecting managers according to past performance figures first and brand second is widely acknowledged to be a poor way to select a manager” (paragraph 5.44).

Segregated Funds – CAPS Sample Quarterly returns on UK equity portfolio of 2,364 occupational segregated pension funds Identifies the fund management house managing the fund in each quarter: 275 fund management houses In-house and external Performance of fund manager measured by average abnormal returns of funds under management Alternative benchmarks taking account of style considerations: three factor model taking account of size and value/growth

Asset-class Allocation by UK Pension Funds

Structure of Pension FM Industry

Performance of Fund Managers (annualised) Mean AR=

Performance Persistence Methodology Performance ranked portfolio strategies Sort fund managers each year into quintile portfolios over ranking period Measures average quintile-portfolio abnormal return over evaluation period Contingency tables Percentage of repeat winners Cross-product ratio CP Independence of cells

Findings Some evidence of performance persistence at one-year, out to three-year horizons Evidence of persistence in abnormal returns weakens at longer time horizons Returns on “Arbitrage portfolio” of long in winners and short in losers over past 12 months generates annualised return of 1.57% Evidence that funds choose managers on basis of past performance, particularly when changing managers

Persistence Tests based on 3-factor Abnormal Returns of Fund Manager Performance AV5AV1DIFTDIF 1QR-1QE QR-4QE * 12QR-12QE * 20QR-20QE NPRWCPZ-statCHI 1QR-1QE8, QR-4QE1, * * 12QR-12QE * * Performance ranked portfolio strategies: Contingency tables:

Do pension funds base choice of manager on past performance?

What if we only consider quarters when funds are changing manager?

Personal Pensions - Micropal 506 exempt unit trusts in UK equity portfolios June December 2000, (247 months) Strong evidence of persistence at medium-term time intervals of between 6 to 12 months Negative persistence at short horizons, weak positive persistence, at longer time intervals.

Persistence Tests based on 3-factor Abnormal Returns of Personal Pension Performance # periodsAV5AV1DIFTDIF 1MR1ME * MR3ME MR6ME * MR12ME * MR36ME N PRWCPZ-statCHITCS 1MR1ME54, * *-33.32* 3MR3ME17, * 6MR6ME8, * *4.63* 12MR12ME3, * *9.26* 36MR36ME *

Comparison of Personal & Segregated Fund Manager Performance

Persistence Tests based on 4-factor Abnormal Returns: Exact comparison of SF & PP Performance

Average abnormal performance of pension fund equity-managers close to zero Significant performance persistence at 1 year horizon, and up to 3 years, but persistence weakens at longer horizons Evidence that fund choose managers on basis of past performance Caveats: Substantial transactions costs in shifting a pension funds’ assets from one fund manager to another, on yearly basis No allowance for the costs of fund management. Myners (2001) suggests annual costs of 40 basis points of the funds under management for a £100 million mandate. Similar evidence on persistence for unitised personal pensions Conclusions