Pension funds have three types of motivations for herding: rebalancing rules, the effects of regulatory changes and peer pressure of senior executives. A new empirical study detects all of these in the trading flows of the large Dutch pension funds. These flows offer opportunities for contrarian traders that provide liquidity to the “herd”.

Broeders, Dirk, Damiaan Chena, Peter Minderhoud and Willem Schudel (2016), “Pension funds’ herding”, De Nederlandsche Bank, Working Paper No. 503, February 2016.

This post ties in with market price distortions induced by rules-based flows of large institutions.

Previous posts on the subject of herding dealt with the efficiency of herding for poorly informed managers (view post here), the role of markets-implied information and information risk (view post here), the rationality of informational herding in critical times (view post here), the low overall confidence of market participants and the preciousness of private information (view post here), reputational incentives for herding (view post here), the role of risk management, conventions and regulations (view post here), herding related to the presence of large mutual funds in small emerging local markets (view post here) and the consequences of herding in form of escalatory dynamics, liquidity problems, and pricing inefficiencies (view post here).

The below are excerpts from the papers. Headings, links and cursive text have been added.

Why institutional investors herd

“[Academic authors] define herding as a group of investors trading in the same direction over a period of time. In order to analyse this thoroughly we distinguish between weak, semi strong and strong herding behaviour. Weak herding is related to the information motive…semi strong herding to the regulation motive and strong herding to the reputation motive.”

There is also a more narrow definition of herding as a conscious decision by agents to mimic the actions of others (view post here), which corresponds to the case of “strong herding” below.

Why pension funds herd

“Pension funds are typically constrained…by the size and the nature of the liabilities, the risk preferences of the key stakeholders and by external regulation…

  • We define weak herding behaviour as the result from the fact that pension funds have similar rebalancing strategies… by aiming for a fixed asset allocation…This unintentional…form of herding occurs because groups face similar decision problems and information sets and take similar decisions…Since most pension funds aim for a more or less fixed asset allocation within a narrow bandwidth, they typically will buy equities following a period in which the equity allocation decreased.
  • Semi strong herding arises when pension funds react similarly to other external shocks, such as changes in regulation and exceptional monetary policy operations… [Other papers] show that regulation can have a significant impact on pension fund’s investment decisions… Examples can be found of this so-called characteristic herding…the introduction of risk-based solvency standards resulted in an increased demand for government bonds by Swiss insurance companies in 2006…Another example is the shift from equities to bonds by UK pension funds due to the introduction of fair value accounting in FRS17 in 2003…GASB regulation of US public pension funds favours equity investments as the level of the liability discount rate is derived from the expected return on assets.
  • Finally, strong herding means that pension funds intentionally replicate changes in the strategic asset allocation of other pension funds… This could be the case if a group of pension funds follow changes in the strategic asset allocation of another pension fund or a group of pension funds. In this type of herding, an informed agent follows the trend even though that trend is counter to his initial information about the asset value. Reputation-based or strong herding…can be divided in two subclasses: career pressure and peer group pressure. [A] Due to career pressure managers will ‘follow the herd’ if they are concerned about how others will assess their ability to make judgements. In other words, asset managers may be concerned about their labour market position and therefore may choose to mimic investing behaviour of other asset managers.. [B] Peer group pressure…occurs if the risk-taking behaviour of an individual asset manager is affected by the risk-taking behaviour of other managers in his peer group [for example due to benchmarking effects, view post here].”


“EIOPA recently provided evidence that pension funds contribute to financial stability as a result of rebalancing strategies.”

“Reputation herding can be regarded as an inefficient handling of information due to concerns on the reputation of the investor himself… Whereas weak herding can contribute to financial stability, strong herding is a risk for financial stability.”


“Herding behaviour has potential consequences for market volatility…Bubbles can arise when rational investors neglect their own private information because they belief that most other traders have very accurate information, while they are in fact poorly informed….Investors who decide early may be crucial in determining which way the majority will decide. If it turns out, e.g., when new information arrives, that investors who have taken a wrong decision, are likely to start herding in the opposite direction. This increases market volatility…Contrary investors benefit from providing liquidity to herding asset managers by trading against them.”

Evidence for herding of the large Dutch pension funds

“This paper seeks to shed light on herding behaviour among Dutch defined benefit funds. The Dutch pension system is relatively large in terms of size: total assets represent roughly twice the size of GDP of the Netherlands.”

“We use a unique dataset from De Nederlandsche Bank, containing monthly transaction data of large Dutch occupational pension funds across a period from January 2009 until January 2015…we use monthly holdings and transaction data of 39 large Dutch pension funds.”

“We find empirical evidence for all three types of herding

  • Pension funds exhibit weak herding behaviour. Pension funds rebalance their asset allocation in the short run and, hence, they react similar to market information. We find robust evidence that more than 20% of the passive changes in the equity allocation are offset by active changes during the month. For bonds this rebalancing of the asset allocation accounts for almost 25%. Since rebalancing implies a buy low and sell high strategy, pension funds contribute to financial market stability…
  • Pension funds demonstrate semi strong herding behaviour. We find multiple examples where pension funds adjust their equity and bond allocation around (the announcements of) changes in pension fund regulation
  • Pension funds also display strong herding behaviour. The most robust evidence of strong herding is obtained for pension funds with similar size over a 15 to 18 month period. If pension funds increase their equity allocation with 1 percentage point on average, then pension funds with a similar size typically increase their equity allocation by 0.35 to 0.47 percentage points with a lag of 15–18 months. The 18 month period is halfway the typical three year cycle at which the strategic asset allocation is reviewed and adjusted. Our results indicate support for the information, regulation and reputation motives of herding.”