Decentralization in Pension Fund Management

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 in coordinating multiple managers by reducing their overall risk budget following decentralization, which helps to compensate for the suboptimal diversification that results. In summary, our results shed light on the complex array of factors that affect the decision of pension funds to delegate investment choice.