Pension Plan Allocation to Real Estate when Plan Trustees have Reputational Utility
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Pension Plan Allocation to Real Estate when Plan Trustees have
Reputational Utility
Kiat-Ying Seah and James D. ShillingNational University of Singapore
DePaul University, ChicagoERES 2010Milan, Italy
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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
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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.
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Pension Trustee’s Objective function Measure reputation by an entropy function
Objective of each plan trustee: maximize reputation subject to a shortfall constraint
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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.
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Given beliefs, solve for portfolio
1. Power utility form, risk aversion is endogenous2. What matters?
• Target returns, W0Z• Surplus returns ST
Initial Funding Ratio matters
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Data and Results Data are obtained from CRSP/COMPUSTAT 1990-2004. Summary Statistics:
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Summary Statistics
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Portfolio Simulations
1. SRMP looks at total portfolio variance2. Entropic cares about the entire distribution
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Empirical Evidence Use Sharpe’s (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)
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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.