Financial Analysts Journal 21 February 2018 Volume 74 Issue 1
What Free Lunch? The Costs of Overdiversification
Institutional investors, charged with outperforming a policy benchmark, often allocate to external active managers in order to hit their return objective. The challenge is to do so without overdiversifying the plan. Hiring too many managers can significantly reduce active risk, leaving the plan with high fees and limited ability to outperform a policy benchmark. We review the number of external investment strategies held by the largest US public and corporate pension funds. Our analysis shows that most large pension funds are overdiversified, allowing us to suggest a simpler framework for moving forward.
About the Author(s)
Shawn McKay, CFA, is senior investment strategist, Investment Solutions Group, at State Street Global Advisors, Boston.
Robert Shapiro, CFA, is senior investment strategist, Investment Solutions Group, at State Street Global Advisors, Boston.
Ric Thomas, CFA, is senior managing director and global head of strategy and research in the investment solutions group at State Street Global Advisors (SSgA). Previously, he served as head of alternative investments and head of global enhanced equity at SSgA. Mr. Thomas also worked as a quantitative analyst in fixed income at Putnam Investments and as an assistant economist at the Federal Reserve Bank of Kansas City. He serves on the investment committee for the Colorado State University Foundation. Mr. Thomas holds a BA in economics from Colorado State University, an MA in economics from the University of Colorado, and an MBA from the University of Chicago.