Fiduciary Investment Under Uncertainty: Examining Pension Plan Investment Behavior When Trustees Have Reputational Utility

Abstract

Pension funds investment behavior have found to be persistent over time. Empirical findings of such persistence support conjectures that belief biases such as overoptimism and reputational concerns affect fiduciary investment behavior. Standard mean-variance analyses do not consider the implications of prudent-man laws on pension fund investment. We suggest an alternative way to derive pension portfolio choice by explicitly allowing pension trustee to make a joint belief-allocation choice in a utility function which takes an entropic form and considers investment objectives in a fiduciary environment. Our results demonstrate that pension trustees are inherently optimistic in forming projections but such optimism increases with the degree of risk-aversion. Further, the higher the level of risk-aversion, the more likely trustees will conform to peer group consensus and the less likely the consensus will change over time. This pattern of investment behavior seems consistent with empirical observations.