Practical analysis for investment professionals
14 August 2017

Pension Trustees: Corporate Governance and the Behavior Gap

When I entered institutional investing, I believed this buttoned-down world would be different — at least from the retail space.

I expected professional boards composed of professional people with business backgrounds and advanced academic degrees. I imagined institutional investment management would be like the Intel Pentium MMX commercials from the late 1990s, those “Play that Funky Music” ads with the people in the white clean room suits: predictable and dependable, not a speck of dust and nothing out of place.

I was in for an awakening. It turns out boards and investment committees are like everything else — imperfect entities run by imperfect people. They can be distracted, emotional, self-interested, unengaged, and at cross-purposes, often with members who lack investment training or experience.

At about the same time, I began to teach a unit on corporate governance at Marquette University. These two developments prompted me to wonder: What if we look at asset ownership organizations — pensions, foundations, and endowments — through a similar lens as corporate governance? Could we help these organizations do better?

Based on this initial theory, I came up with a five-year PhD research project. I soon discovered that if you want data on this topic, you have to generate it yourself. While good financial and actuarial data on public pension funds was available, there was a dearth of reliable information on governance. So with my colleagues at the Marquette University business and law schools, we created a research protocol and began to gather the data.

I feared the investment performances of public pension funds would all look the same. I retained that image of those spotless clean room suits. After all, the country’s largest investment funds were staffed by the most professional investors, right? And they all faced similar conditions: the same demographics, long-term objectives, budgetary constraints, market cycles, interest rate climate, and maybe even the same consultants. If as I assumed, investment performance was more or less uniform across the sector, then what was there to talk about?

That fear was misplaced.

Public Pension Funds Five-Year Average Returns, 2008–2012

Public Pension Funds Five-Year Average Returns, 2008–2012

Source: “Asset Owner Governance and Fiduciary Effectiveness: The Case of Public Pension Funds,” by Christopher K. Merker, PhD, CFA, ©2017, Marquette University

The above chart shows the five-year average performances of 35 public pension plans that together represent about 14.5% of the total public pension industry by assets. What’s striking is the variability: Between 2008 and 2012, the best plan annualized at 15%, the worst at -4.2%. The S&P 500, meanwhile, generated an average 1.4% return, while a balanced index portfolio composed of 60% S&P 500 and 40% Barclays Aggregate Bond Index returned about 4.5%. Note: more than half performed below the average, which was about equal to the balanced index return.

When digging into asset allocations among the various plans, we found significant differences in investment approaches.

Since the performances and funding ratios varied so much, we started to examine why. In one of his many adroit doodles, the financial cartoonist Carl Richards captured what we suspected and ultimately found to be the principal difference:


Source: “Above the Market,” by Carl Richards,

Simply defined, asset owner governance is codified and structured group investor behavior. The gaps we found in performance were behavioral gaps.

It turns out that the same behavioral biases that influence individual investors also affect pension fund trustees. Behavior drives choice and choice drives outcomes. Governance practices have a direct effect on the choices boards make in their allocations and investments.

Several factors emerged as key to performance. The institutional knowledge of the organization, for one. How consistent were the players? How often did they turn over? If turnover was high, there was less organizational stability and a less consistent strategy. This eroded performance.

Other critical factors included professionalism, board composition, engagement, staff, and diligence.

One component of professionalism is obvious: How often does the board meet? The data shows that monthly meetings were better than quarterly.

A less obvious factor: What percentage of board members are retired? Statistically, retirees made for better members. Why? Probably because they have more time to devote to the organization.

Another important influence is staff involvement. Since board members have limited time, knowledge, or both, delegating to reliable staff empirically drives better results. The same is true with the consultant.

One surprising result from our study: Of all the variables incorporated into our model, investment expenses was one of two that was not statistically significant — the other being required contribution rate.

But what was our most important finding? That governance influences investment performance.

How do we know?

Fiduciary Effectiveness Quotient (FEQ) Scores* and Investment Returns by Quintile

Fiduciary Effectiveness Quotient (FEQ) Scores and Investment Returns by Quintile

When public plans are broken down by the Fiduciary Effectiveness Quotient (FEQ) score, the top 20% outperformed the bottom fifth by nearly 2 to 1.* We also found that every unit of improvement in the FEQ resulted in a 0.36% increase in investment performance over the five-year period. This relationship persisted under a one-year lag, so organizations shouldn’t wait to implement meaningful change.

The takeaway is simple: Good governance drives real results. And our research demonstrates that governance can now be measured.

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images/Phil Boorman

*The Fiduciary Effectiveness Quotient (FEQ) is a trademark of FGA-Diagnostics, LLC.

About the Author(s)
Christopher K. Merker, PhD, CFA

Christopher K. Merker, PhD, CFA, is a director with Private Asset Management at Robert W. Baird & Co. He is also director of the sustainable finance and business program at Marquette University, and executive director of Fund Governance Analytics (FGA). He recently served on the CFA Institute ESG Working Group, responsible for leading the development of global ESG standards. He publishes the blog, Sustainable Finance, and is co-author of the book, The Trustee Governance Guide: The Five Imperatives of 21st Century Investing. Chris received his PhD from Marquette University and MBA from Thunderbird, School of Global Management.

1 thought on “Pension Trustees: Corporate Governance and the Behavior Gap”

  1. Bud Haslett, CFA says:

    For more information on this topic, check out the Research Foundation publication A Primer for Investment Trustees.

Leave a Reply

Your email address will not be published. Required fields are marked *

By continuing to use the site, you agree to the use of cookies. more information

The cookie settings on this website are set to "allow cookies" to give you the best browsing experience possible. If you continue to use this website without changing your cookie settings or you click "Accept" below then you are consenting to this.