Familiarity Breeds Underperformance: Evidence from US Defined Benefit Pension Plans

Abstract

We provide evidence that sponsoring firms’ characteristics affect the investment policy of large defined-benefit (DB) corporate pension plans. We show that sponsoring firms that have a higher proportion of foreign sales have pension plans that invest more in international assets, whereas sponsoring firms that spend more on research and development have a higher proportion of their pension assets invested in private equity and venture capital. Similarly, we find that sponsors with more tangible assets have pension plans asset allocation tilted towards real estate. We analyze the effect of the investment bias toward familiar asset classes on pension plan returns and sponsors’ contributions to shed light on the value of focus and familiarity biases. Our findings show that pension plans with asset allocation tilted towards the sponsoring firm focus have lower and more volatile returns and higher contributions. We test whether or not we can predict what type of funds will have their portfolios tilted and we shed light on the literature on familiarity biases.