Holders of the Purse Strings: Governance and Performance of Public Retirement Systems

Public sector pension plans are managed in diverse ways, with governance policies distinguished according to their board composition and size, how the trustees structure their investment decisions, what restrictions are placed on their investments, and whether they have independent performance evaluations. We examine how these governance policies affect pension investment strategies, and how those strategies in turn affect the funds' financial performance. Methods. Drawing on two national surveys of state and local public retirement systems in 1992 and 1993, we ask if pension governance policies affect whether they (1) invest tactically in response to changing conditions; (2) allocate assets between equities and fixed-income holdings; (3) contract for external asset management; and (4) invest outside the U.S. Results. Empirical analysis reveals that government policies - especially independent performance evaluations - predict investment decisions in all four areas. These investment strategies are found in turn to affect subsequent fund performance: preferential investing in equities and abroad increased annual returns on their asets by as much as one to two percentage points. Conclusions. The ways that public pensions are governed have a direct bearing on how they invest their assets, and the investment strategies in turn directly affect the financial performance of their holdings.