Pension Plan Allocation to Real Estate when Plan Trustees have Reputational Utility

1
Pension Plan Allocation to Real Estate when Plan
Trustees have Reputational Utility

• Kiat-Ying Seah and James D. Shilling
• National University of Singapore
• DePaul University, Chicago
• ERES 2010
• Milan, Italy

2
Objectives

• Tries to explain why institutions invest very
  little in real estate.
• 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

3
Motivation

• Reality institutions invest 2.5 to 4 of total
  assets in real estate
• Normative studies
• 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.

4
Pension Trustees Objective function

• Measure reputation by an entropy function
• Objective of each plan trustee maximize
  reputation subject to a shortfall constraint

5
Allocation is a function of belief-choice

• Optimal belief choice multinomial logit
  probabilistic choice function
• Trustees will skew their portfolio toward assets
  with higher returns.
• Prob of choosing a target that deviates from
  group mean is low conforming behavior.

6
Given beliefs, solve for portfolio

• Power utility form, risk aversion is endogenous
• What matters?
• Target returns, W0Z
• Surplus returns ST

Initial Funding Ratio matters
7
Data and Results

• Data are obtained from CRSP/COMPUSTAT
• 1990-2004.
• Summary Statistics

8
Summary Statistics
9
Portfolio Simulations

1. SRMP looks at total portfolio variance
2. Entropic cares about the entire distribution

10
(No Transcript)
11
(No Transcript)
12
Empirical Evidence

• Use Sharpes (1992) style methodology
• 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)

13
(No Transcript)
14
Conclusion

• Empirical results are the same when we include
  firm fixed effects.
• Reputational utility causes institutions to
• 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.