Pension Plan Allocation to Real Estate when Plan
- Slides: 14
Pension Plan Allocation to Real Estate when Plan Trustees have Reputational Utility Kiat-Ying Seah and James D. Shilling National University of Singapore De. Paul University, Chicago ERES 2010 Milan, Italy
Objectives p Tries to explain why institutions invest very little in real estate. n n An entropy model where institutions care about what their target returns are Conformity matters Persistent portfolio allocation Implication: allocation is based on a power utility not on a mean-variance variety
Motivation p p Reality: institutions invest 2. 5% to 4% of total assets in real estate Normative studies: n n n p 15 -20% (Fogler, 1984) 43% (Webb and Rubens, 1987) 19 -28% (Giliberto, 1993) Modelling idea: - Pension plans are fiduciaries and care about how others assess their performance: include “Reputation” in utility function.
Pension Trustee’s Objective function p Measure reputation by an entropy function p Objective of each plan trustee: maximize reputation subject to a shortfall constraint
Allocation is a function of beliefchoice p Optimal belief choice: multinomial logit probabilistic choice function n n Trustees will skew their portfolio toward assets with higher returns. Prob of choosing a target that deviates from group mean is low – conforming behavior.
Given beliefs, solve for portfolio 1. Power utility form, risk aversion is endogenous 2. What matters? • Target returns, W 0 Z • Surplus returns ST Initial Funding Ratio matters
Data and Results Data are obtained from CRSP/COMPUSTAT p 1990 -2004. p Summary Statistics: p
Summary Statistics
Portfolio Simulations 1. SRMP looks at total portfolio variance 2. Entropic cares about the entire distribution
Empirical Evidence p Use Sharpe’s (1992) “style” methodology: n n Regress pension surplus returns on six benchmark returns. Collect R-square statistic for each pension plan. Because R-square varies from 0 to 1, transform this variable using the logistic transformation = “STYLE” variable Run the following regression: Style = F (Target surplus return, Conformity, Initial Funding Ratio)
Conclusion Empirical results are the same when we include firm fixed effects. p Reputational utility causes institutions to p n n n Skew portfolio away from real estate to achieve minimum target rate of return. Achieving minimum target rate of return requires that pension trustees be conformists. Explains herding behavior.
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