The Return Expectations of Institutional Investors

Abstract

Analysis of required expected return disclosures by public pension funds in individual asset classes reveals a reliance on past performance in setting return expectations. These extrapolative expectations operate through the expected risk premium and occur across all risky asset classes. Pension plans act on their extrapolated expectations by adjusting their target asset allocations. Pension funds extrapolate performance more when executives have personally experienced a longer performance history with the fund, and when employing certain investment consultants. The results cannot be explained by differential risk-taking, persistent investment skill, efforts to reduce costly rebalancing, or fiscal pressure from unfunded liabilities.

Keywords: Institutional investors, return expectations, asset allocation, portfolio choice, return extrapolation

JEL Classification: G02, G11, G23, G28, H75, D83, D84