NBER WORJ(ING PAPER SERIES PENSION FUND INVESTMENT POLICY

The purpose of this paper is to survey what is known about the investment policy of pension funds. Pension fund investment policy depends critically on the type of plan: defined contribution versus defined benefit. For defined contribution plans investment policy is not much different than it is for an individual deciding how to invest the money in an Individual Retirement Account (IRA). The guiding principle is efficient diversification, that is, achieving the maximum expected returnfor any given level of risk exposure. The special feature is thefact that investment earnings are not taxed as long as the moneyis held in the pension fund. This consideration should cause theinvestor to tilt the asset mix of the pension fund towards the least tax—advantaged securities such as corporate bonds. For defined benefit plans the practitioner literature seemsto advocate immunization strategies to hedge benefits owed to retired employees and portfolio insurance strategies to hedgebenefits accruing to active employees. Academic research into the theory of optimal funding and asset allocation rules for corporate defined benefit plans concludes that if their objectiveis shareholder wealth maximization then these plans should pursu