Decentralized Investment Management: Evidence from the Pension Fund Industry

David Blake, Allan Timmerman, Ian Tonks and Russ Wermers

The past few decades have seen a major shift from centralized to decentralized investment
management by pension fund sponsors, despite the increased coordination problems that this
brings. Using a unique, proprietary dataset of pension sponsors and managers, we identify two
secular decentralization trends: sponsors switched (i) from generalist (balanced) to specialist
managers across asset classes and (ii) from single to multiple competing managers within
each asset class. We study the effect of decentralization on the risk and performance of pension
funds, and find evidence supporting some predictions of recent theory on this subject.
Specifically, the switch from balanced to specialist managers is motivated by the superior
performance of specialists, and the switch from single to multiple managers is driven by sponsors
properly anticipating diseconomies-of-scale within an asset class (as funds grow larger)
and adding managers with different strategies before performance deteriorates. Indeed, we
find that sponsors benefit from alpha diversification when employing multiple fund managers.
Interestingly, competition between multiple specialist managers also improves performance,
after controlling for size of assets and fund management company-level skill effects. We also
study changes in risk-taking when moving to decentralized management. Here, we find that
sponsors appear to anticipate the difficulty of coordinating multiple managers by allocating
reduced risk budgets to each manager, as predicted by recent theory, which helps to compensate
for the suboptimal diversification that results through an improved Sharpe ratio. Overall,
our results indicate that pension fund sponsors, at least on average, rationally choose their
delegation structures.

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