Witnesses to a revolution

The landscape of institutional investing was beginning a transformation at the time Pensions & Investments published its initial issue in October 1973.

Institutional investors and their money managers began driving the market. The trend away from bank trust departments led to the creation of the professional institutional investment management industry.

New regulations also drove changes. Plus, economic, geopolitical events and scandals buffeted the portfolios overseen by institutional investors. In reaction, asset owners moved into more asset classes as part of an effort to diversify and strengthen their risk management for protection against downturns.

In turn, pension funds, mainly public and union, awakened to the attention their vast assets commanded. They sought to bring more accountability and combat misbehavior through spearheading reforms in corporate governance and participating in securities litigation.

Over P&I's existence, the definition of an institutional investor has expanded to include not only pension funds, endowments and foundations, but also sovereign wealth funds, central banks and not-for-profits like hospitals.

Here are the top innovations, changes and events since 1973:

President Gerald R. Ford on Labor Day 1974 signed the Employee Retirement Income Security Act, or ERISA, which fundamentally changed regulatory oversight of corporate pension funds.

The landmark legislation created the Pension Benefit Guaranty Corp. a government-run program protecting participants' benefit payments in terminated pension plans, and compelling corporate and other ERISA-regulated defined benefit plan sponsors to pay premiums for that protection. It was the beginning of increasing legislative and regulatory oversight of private-sector pension plans.

ERISA provided “a framework for plan sponsors and administrators for how to manage and invest pension plan assets,” said Zainul Ali, head of manager research, Americas, in Towers Watson & Co.'s Toronto office.

It included the notion of fiduciary responsibility, which led to the formation of investment committees and the requirement that the assets be invested for the sole benefit of plan participants, he said.

At the time ERISA became effective, U.S. private pension assets totaled $150 billion, according to P&I; as of March 31, 2013, they totaled $6.82 trillion, according to the Federal Reserve.

In the early 1970s, defined benefit plan assets in aggregate were enormous by the relative standards of the day, although tiny by today's measures. Private-sector defined benefit plans had in aggregate $186 billion in 1975, according to the Department of Labor's Employee Benefits Security Administration.

In the public sector, the pension assets of 50 states and 50 top municipalities totaled $82 billion, according to a P&I report Oct. 7, 1974. Among them, the California Public Employees' Retirement System was called by a “giant” by P&I, with $6.1 billion in assets. Defined benefit plans' growth and influence became headline news. In 1985, NBC broadcast a documentary, “The Biggest Lump of Money in the World,” focused on the power of DB plans.

But while DB assets continued to grow enormously, corporations began to look for ways to reduce the costs of providing retirement benefits in the decade following the passage of ERISA, either by replacing them with 401(k) plans or moving to hybrid defined benefit plans.

In 1985, Bank of America Corp. became the first major corporation to adopt a cash balance plan. Kwasha Lipton, a Fort Lee, N.J., benefits consulting firm was credited with originating the concept.

The development of cash balance and other hybrid plans, including the pension equity plan, mixed elements of DC plans with an underlying defined benefit plan. The Internal Revenue Service gave tacit approval of cash balance pension plans through non-discrimination regulations issued in 1991.

More than 1,000 U.S. companies had converted to or started cash balance plans by 2004, accelerating the move away from traditional DB plans and sharing more investment risk with participants.

More recently, adjustable pension plan design has begun to take root. Under it, benefits shrink or grow depending on investment performance, allowing plan sponsors “to drastically reduce their risk, while still providing lifetime income to participants,” according to a P&I story April 29, 2013.

Regulation costs and unfavorable markets hurt pension assets and liabilities. Those, plus competitive business pressure, led companies to freeze or terminate DB plans.

The public sector has largely resisted pressure so far to move away from traditional DB plans. But deep underfunding, concerns about liquidity and solvency — often the result of shortchanging actuarially required contributions — along with an antipathy from taxpayers, are giving more credibility to critics of public DB plans.

A giant nail in the coffin of defined benefit plans came with the development and growth of defined contribution plans. In 1975, 88% of employees in private companies with retirement plans were covered by DB plans, dropping to 33% by 2005 and 7% in 2011, the most recent data available, according to Employee Benefit Research Institute.

“From my perspective, it's hard to overstate the impact ... when section 401(k) was added to the Internal Revenue Code. It turned the world of retirement plans upside down,” said Alan Glickstein, senior retirement consultant at investment consultant Towers Watson, Dallas.

Some say benefits consultant Theodore Benna created the first 401(k) plan — for the Johnson Cos., Newton, Pa. — a deferred compensation plan with an employer match.

What was initially intended to be a supplemental savings plan now does much of the heavy lifting on retirement savings. The Labor Department said there were 513,000 401(k) plans in 2011, the most recent data available, although about 300,000 had fewer than 25 participants. By contrast, there were 45,257 defined benefit plans in 2011 with a total of 40.8 million participants, according to the DOL.

The 401(k) plan shifted investment decisions, and therefore the responsibility for retirement income, to participants from employers. Simply put, there was no pension promise like there was with a defined benefit plan.

Defined contribution plans “don't have a built-in lifetime income option,” Mr. Glickstein said.

“If there is one thing that ... defines retirement it is to accumulate enough money so you can sustain yourself economically during retirement. ... If the vehicle doesn't have a lifetime income option, it doesn't look like a retirement plan.”

There was a record $4.23 trillion in defined contribution plans in 2012, up from $469 billion in 1980, according to P&I data. DC assets were $74 billion in 1975, according to the DOL.

Until the recent past, the defined contribution industry had focused on helping participants accumulate assets through such innovations as automatic enrollment and investment advice. Now, the emphasis is on ensuring participants have an adequate income at retirement, including developing and using lifetime income options and educating about retirement readiness.

Since their creation, defined contribution plans have not been immune to legislative and regulatory oversight.

The government has acted on everything from investment advice to fee disclosure. Perhaps the biggest regulatory move came in the Pension Protection Act of 2006, which enabled target-date funds to become qualified default investment alternatives.

Target-date funds offered by the top 20 managers of proprietary target-date strategies used by DC plans now claim a total of $601.8 billion as of June 30, 2013, according to P&I data.

The PPA also gave plan participants rights to diversify out of employer stock. Company stock holdings in DC plans fell to a 15.6% allocation as of Sept. 30, 2012, from 24.7% in 2006, according to P&I data.

The Labor Department's fee-disclosure regulations took effect in July 2012, requiring plan sponsors to disclose certain fee and investment information to plan participants in ERISA-covered plans that include the vast majority of 401(k) and private-sector 403(b) plans.

The latest issue with which DC plan executives are struggling is how to best illustrate how accrued benefits can be converted into an estimated lifetime stream so plan participants don't outlive their savings.

Other than ERISA, probably the two most significant federal laws affecting institutional investors are the Dodd-Frank Wall Street Reform and Consumer Protection Act and Sarbanes-Oxley Act of 2002.

Signed into law by President Barack Obama on July 21, 2010, Dodd-Frank was touted by the Council of Institutional Investors, Washington, as “the most sweeping overhaul of U.S. financial regulations since the 1930s.”

One of the most talked-about provisions is the so-called Volcker Rule, which would limit proprietary trading by federally insured financial institutions. The rule is due to be implemented by July 2014. It would also limit banks' investments in some alternative investments including hedge funds and private equity to prevent them from taking on too much risk.

Dodd-Frank also contains important corporate governance provisions that gave shareholders, including institutional investors, more say in the boardroom. The law also requires pension plans to comply with central clearing of swaps, which some plans use to decrease funding volatility.

Sarbanes-Oxley toughened public company accounting oversight and promoted investor protection. The act has pushed companies to keep a tight grip on their financial reporting, including expenses. Passed after the collapse of Enron Corp. and accounting firm Arthur Anderson LLC, it also requires more transparency in corporate accounting and oversight of auditing firms.

The Financial Accounting Standards Board was established in 1973, the same year P&I published its first issue.

The organization grew to have enormous influence on pension fund finances and investment management, as well as on corporation operations, revealing the impact of pension assets and liabilities on corporate income statements and balance sheets.

Financial Accounting Statements 87 and 88, issued in 1985, were the first major pension accounting rules. While FAS 88 dealt with pension curtailment and termination issues, FAS 87 enhanced disclosure of pension assets and liabilities, income and expenses while standardizing measurement to improve comparability among companies. The rules were designed to link pension plan finances to a company's operations.

The FASB contributed considerably to bringing transparency to corporate pension finances. Its statements, and subsequent pension accounting standards, more clearly revealed how costs of pension benefits and the value of pension assets promote or detract from a company's financial well-being. And FASB disclosure rules changed the way investors valued companies.

In more recent years, the FASB has considered introducing more of a mark-to-market approach to pension accounting but so far hasn't taken action.

In 1984, the Financial Accounting Foundation established the Governmental Accounting Standards Board. GASB has contributed to bringing more clarity to public-sector pension accounting. New rules effective this year and next require, among other features, adding net unfunded liability to financial balance sheets of public-sector retirement system sponsors.

The introduction of index fund investing coincided with the birth of Pensions & Investments. Passive management was a radical and controversial departure from the active approach that was the order of the day for investing. Pioneers working separately were William L. Fouse at Wells Fargo Bank in San Francisco and Rex A. Sinquefield at American National Bank & Trust Co. in Chicago.

They were early adopters of the academic theory on efficient markets, a concept developed by Eugene Fama as an assistant professor at the University of Chicago and published in 1965. The breakthrough in making indexing practical was weighting components by market capitalization. Vanguard Group, under founder John C. Bogle, introduced the first index mutual fund in 1976.

The objective was to match, not outperform, the market return, a concept dismissed by active managers. Over time, academic studies showed indexing generally outperformed active equity management in the long term.

By the end of 1976, index fund managers reported a total of $1.7 billion in indexed assets under management. Worldwide internally managed index assets totaled $7.3 trillion as of June 30, 2013.

Risk management practices have tended to lag investment management capabilities. From staffing of professionals to analytical tools, risk management has generally been a secondary consideration compared to investment management.

Huge losses by pension funds and other institutional investors through various crises have exposed the inadequacy of risk management, including underestimation of risks, insufficient risk control approaches and failure of analytical tools to capture all potential risks. In general, there has been a failure to “keep pace with rapidly evolving financial markets and instruments,” according to a P&I story.

While efforts have lagged, institutional investors have sought to incorporate risk management into the investments of their funds since the application of Harry Markowitz's mean-variance optimization, dating to at least 1973. It was “the first risk management system for portfolios,” and “it has proven robust enough to remain in wide use today,” Bruce Jacobs, principal, Jacobs Levy Equity Management Inc., Florham Park, N.J., said in an e-mail.

Pension funds have tended to step up risk management following each crisis. The Barings PLC collapse in the mid-1990s gave rise to strengthening risk management at the entire fund level.

Risk management tools, especially value at risk, began to gain a foothold in the mid-1990s. Some larger pension funds created new risk control officer positions.

The high-tech bubble of the early 2000s and resulting losses exposed the insufficiency of risk management and failure to keep up with evolving complexity of the markets. But the losses of the 2008 financial market crisis revealed the inadequacy of earlier efforts to enhance risk control. It brought to light new kinds of risk, the so-called black swan, or an unprecedented and unexpected meltdown of financial market assets and correlation risk from the flawed perception of diversification advantages of asset classes to mitigate overall downward volatility.

Since then, asset owners working with consultants and investment managers have developed new sets of tools, while enhancing existing ones with the aim of improving risk management efforts.

While pension sponsors focused on toughening the risk management of pension assets, the crisis also exposed the vulnerability of pension liabilities and the need to consider managing the risks posed by underfunding.

Even though individuals, such as Ronald Ryan, founder of Ryan Labs, had earlier developed a liability-driven investing index when he was at the now-defunct Lehman Brothers Holdings Inc., pension plan executives “had not gotten the memo” that they should match liabilities to assets, said Phil Shaffer, managing director at Graystone Consulting based in Columbus, Ohio. That realization led to more focus on managing funding levels, doing so through use of techniques such as liability-driven investing.

In addition, the 2008 economic crisis was a wake-up call on systematic risk, an event that can affect the entire market and economy. “Systematic risk cannot be eliminated through diversification,” Mr. Jacobs, pointed out. To enhance early warning of systematic risk, the Department of the Treasury created the Office of Financial Research and the Financial Stability Oversight Council, both established under Dodd-Frank.

They are designed to monitor the financial stability of the financial system and investment practices that might expose the system to risk.

Roger Ibbotson and Mr. Sinquefield released a breakthrough study in 1975 comparing historical returns of stocks, bonds, Treasury bills and inflation, from 1926 through 1974.

The returns series, which continues to be updated by Morningstar Inc., provided the intellectual and empirical foundation for allocating investible assets to major, conventional asset classes, based on returns and risk, measured by standard deviation.

Their research changed the way institutional investors managed money. It became the standard reference for asset allocation and benchmark for performance for active money management as well as contributing to making the S&P 500 the primary U.S. equity benchmark for performance evaluation.

Their research drove more institutional assets into equities, showing stocks prevailed in the long run. The research became a rationale for index fund investing as well.

Forty years ago, there were barriers preventing most U.S. asset owners from investing abroad.

The barriers were lifted first in January 1974, when President Richard M. Nixon suspended a law designed to stem foreign investment. Then, in 1976, the Labor Department said international investing would not run afoul of ERISA.

Pension plans did not begin to invest overseas in a big way until 1980. International investment grew to $26 billion in 1985 from $3 billion in 1980, according to P&I.

These days, international investing across traditional and alternative asset classes is widespread. According to P&I's money manager survey, the 200 largest U.S. managers ran a total of $1.533 trillion in international assets as of Dec. 31, 2012.

By the late 1980s, some pension funds and money managers began to invest outside of the major European countries and Japan, moving into the emerging markets.

“Without the flood of U.S. pension money seeking investment opportunities, for example, the stock markets in Hong Kong, Singapore, Indonesia and China would have been far slower to develop exchanges,” wrote Michael J. Clowes, P&I editor at large, in his book, “The Money Flood.”

Global investing got a big boost in 1993. Defined benefit assets invested abroad by the largest 200 plans grew 49.6% to $126.9 billion, fueled by both high market returns and increases in allocations to that class, according to P&I data. Much of the growth in international was in equities, where assets reported by plan sponsors rose 59.5% to $98.6 billion that year. Defined contribution assets invested internationally among the largest 200 funds experienced even greater growth, rising 88.5% to $16.4 billion. The bulk of that growth came in equities, which rose 73.1%.

At the same time, foreign governments began allowing non-domestic money managers to invest pension assets. The reign of Japanese trust banks and insurance companies ended in 1995 with the U.S.-Japan Pension Accord, which eased the way for foreign money management of Japanese corporate and government pension assets. The country's strict asset allocation guidelines were lifted in 1990.

Other countries followed suit.

A bill that removed a tax impeding the use of options in investment management was signed into law in 1976 by President Gerald Ford, paving the way for the first use of derivatives by pension funds and other tax-exempt investors.

Options were the first derivatives used by pension funds. In 1979, pension funds moved into financial futures, then stock index futures, swaps and more complex instruments.

Derivatives gained favor as a low-cost hedging device to control risk, enhance portfolio liquidity and facilitate portfolio allocation moves without disturbing underlying prices.

But the Oct. 19, 1987, stock market meltdown exposed flaws in derivatives, especially portfolio insurance, a strategy that sought to protect portfolios by selling futures in a declining market. The SEC blamed portfolio insurance for contributing to accelerating and exacerbating the market decline.

Still, the use of derivatives continued to grow.

In the 1990s, market neutral, portable alpha and overlay strategies looking to get exposure without buying underlying securities gained appeal. Fast forward to 2008, and overexposure to derivatives got a share of the blame for the financial crisis. As a result, many over-the-counter interest-rate and credit-default swaps must now be registered with derivatives clearing organizations, and asset owners must have liquid collateral to meet margin calls.

Leverage has become increasingly used by institutional investors over the last 40 years.

Early use was in derivatives and in leveraged buyouts.

Use of leverage increased with, among other approaches, the growth of hedge funds. Development of prime brokerage structures allowed institutional investors to circumvent regulation T, which restricts leveraged investing, Jacobs Levy's Mr. Jacobs said in an e-mailed response to questions.

Investors applied leverage to portfolios to enhance returns or mitigate risks. It was one approach in non-traditional investments that asset owners began to use to seek higher returns and lower correlations, especially as interest rates declined and stock returns moderated after 2001, Mr. Jacobs said.

The risk of leverage is that it “can multiply gains, but it can also amplify losses,” Mr. Jacobs said.

As Mr. Jacobs said earlier this year, “Leverage has contributed to or caused many ... financial crises we have experienced. Whether the leverage is in the housing industry, investment banks or hedge funds, the impact has been profound.”

The mutual fund industry has exploded over the last four decades, fueled in large part by the growth of defined contribution assets invested there. While Individual Retirement Accounts fuled the early growth of mutual funds, by the end of 2012, the $2.6 trillion held in IRAs accounted for just 20% of all mutual fund assets. That and all data in this mutual funds report come from the Investment Company Institute, Washington.

At year-end 1975, assets in mutual funds by U.S.-registered investment companies totaled $45.8 billion, according to the ICI. In all, there were 426 funds.

By the end of 2012, assets totaled $13.04 trillion. They were invested in 7,596 funds managed by 724 companies.

Mutual funds held 57% of $5.3 trillion of defined contribution assets, at the end of 2012, up from only 16% at the end of 1991. DC assets in mutual funds accounted for 23% of all mutual fund assets. An increasing part of the growth in mutual funds comes from target-date funds.

Exchange-traded funds, introduced in 1993, have become a competitor of mutual funds, although many are managed by the same companies. At year-end 2012, 1,239 ETFs held $1.3 trillion in assets, up from two ETFs holding $1 billion in assets at year-end 1995.

The endowment of Yale University in New Haven, Conn., was one of the first asset owners to invest in absolute return, also known as hedge funds, with an initial target allocation of 15% in July 1990, according to its latest update for the fiscal year ended June 30, 2012.

The goal was to add diversification and “generate high long-term real returns by exploiting market inefficiencies,” the report states.

Investor interest predated Yale's plunge into the asset class. Cambridge Associates LLC, Boston, began researching hedge funds in 1975, according to a spokesman. Although the firm couldn't provide an exact date for the first hedge fund investments, the spokesman said it is “probable that these institutions began investing in hedge funds before they started working with Cambridge Associates.”

Assets of the 25 largest single and multistrategy hedge fund managers totaled $658.5 billion in the 12 months ended June 30, 2013, according to P&I's annual survey of institutionally oriented hedge fund firms. By comparison, in 1994, total assets of U.S. hedge funds were $120 billion to $160 billion, according to estimates provided to P&I by George P. Van, chairman of International Advisory Group Inc., a Memphis, Tenn., consultant that tracks hedge funds and their performance.

According to Hedge Fund Research Inc., in 1990, hedge funds managed $38.9 billion in institutional and high-net-worth assets.

A major development in institutional investing involved private equity (including venture capital and leveraged buyouts).

One of the first publicized investments in LBOs was by the then-$2.6 billion Oregon Public Employees Retirement System's $100 million investment in 1981 with Kohlberg Kravis Roberts & Co. for the leveraged buyout of Portland, Ore.-based merchandising company Fred Meyer Inc. In 1983, private equity firm Forstmann Little & Co. raised $250 million for an LBO.

These new private equity firms borrowed most of the money to buy up all of the stock of a company or division of a company and take the company private. The idea was to reorganize the company or boost its efficiency, and then take it public again or sell it to another company.

Investors were attracted to private equity for diversification and for the high returns. The Fred Meyer LBO eventually earned KKR and its investors a 400% return. By 1985, P&I estimated that more than $12 billion of pension fund capital was committed to private equity funds. The top 200 U.S. retirement plans had $310.6 billion in private equity as of Sept. 30, 2012, with private equity accounting for 9.4% of total assets of the largest 200 pension funds, according to P&I's annual survey.

U.S. buyout funds outperformed the S&P 500 on average by 20% to 27% over a fund's life and more than 3% annually, according to a paper on private equity returns released this year.

A total of $20 billion was committed to venture capital and $106 billion to buyout and mezzanine in 2012, up from $3.7 billion in venture capital and $3 billion in buyouts and mezzanine in 1985, according to National Venture Capital Association data.

Capital began to flow into venture capital, an investment in younger companies or the transformation of ideas into companies, in 1982. That is when new federal regulations defining plan assets under ERISA cleared the way for institutional investors to invest in the burgeoning asset class.

Real estate equity was the first alternative to U.S. stocks and bonds for institutional investors.

In 1971, Frank Russell Co. estimated that institutional investors had less than $500 million in commercial equity real estate, according to Mr. Clowes. By 1998, the 200 largest pension plans had $79.8 billion in office buildings, factories, shopping malls, warehouses, apartments and hotels. By 2012, that number had grown to $226.9 billion. And, along the way, equity real estate investing moved out of the category of “alternative investments” and into the mainstream asset mix.

Probably the best-known earliest pooled vehicle was Prudential Real Estate Investors' Prudential Property Investment Separate Account, launched in July 1970. By Sept. 30, 1971, PRISA had 20 clients and $50 million in assets. Investors still invest in PRISA, an open-end fund that invests in core properties.

By 1980, pension fund executives bean investing in closed-end funds, which locked up their investment for eight to 10 years, as well as in separate accounts. Some also began to invest directly in real estate.

Investors have moved beyond straight equity real estate investing to include timber, farmland and, most recently, infrastructure in their real asset portfolios.

And while real estate investment trusts date back more than 50 years, the growth of the institutional REIT market got a huge kickoff in the 1980s, when the public markets gave private real estate managers a lifeline. REITs are now a $300 billion market, with both institutional and retail included. The top 200 pension plans had $22.4 billion in REITs in defined benefit plans and $3.6 billion in REITs in defined contribution plans as of Sept. 30, 2012, up from $9.3 billion in REITs in DB plans in 1999, the first year P&I began tracking REIT investments by the top 200 retirement plans. P&I did not track REIT investments in DC plans in 1999.

By 1985, investors' fixed-income portfolios included a variety of mortgage-backed securities, including those that bundled single-family home mortgages. Some investments started in the late 1970s as part of a movement by states and municipalities to invest in in-state mortgages to lower mortgage rates and to stimulate housing construction.

Investment in mortgage-backed securities grew so much that, in 1993, their performance distorted the returns of some fixed-income indexes. Thus, a manager could outperform one index and underperform another.

In the run-up to the global financial crisis, a variety of money managers began to peddle residential mortgage-backed securities and collateralized debt obligations that exposed investors to subprime mortgages and a variety of risky loans disguised as AAA-rated securities. At the same time money managers were selling these securities, some of the same managers were making bets against them. During the crash, investors fled CDOs and RMBS and bought Treasuries.

Searching for higher returns in the 1970s and early- to mid-1980s, institutional investors began to accept more risk, even in their normally conservative fixed-income portfolios.

What emerged was a junk-bond market — bonds with below-investment-grade ratings that had high yields. Many were used to finance LBOs.

In 2012, the largest 200 pension funds had $59.8 billion in high-yield bonds.

But institutional investors' affection for junk bonds took a dive in January 1990, with the collapse of investment banking firm Drexel Burnham Lambert. Michael Milken, known as the junk-bond king and credited with creating the securities at Drexel, ended up in prison for breaking federal securities laws.

Congress also forced savings and loans to dump their junk bonds, which plummeted to — in some cases — below 40% of their face value and led to the collapse of the savings-and-loan industry.

Beginning with Franco Modigliani in 1985, the Nobel Prize foundation recognized a string of academics in financial economics for their enormous influence on institutional investment and corporate finance.

Mr. Modigliani was honored with the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, as the award is called, for his analysis of the financial markets that included corporate financial structure. In 1990, prizes were awarded to Mr. Markowitz, Merton H. Miller and William F. Sharpe. Mr. Markowitz was the pioneer of modern portfolio theory, developing the mean-variance analysis for portfolio allocation; Mr. Miller's work included contributing to understanding corporate finance; Mr. Sharpe, pricing financial assets and measuring risk, including his development of the capital asset pricing model.

In 1997, Robert C. Merton and Myron S. Scholes won for their work in developing a method for valuing derivatives, including working with Fischer Black in creating the Black-Scholes option pricing model. In 2002, Daniel Kahneman and Vernon L. Smith were co-winners. Mr. Kahneman was recognized for integrating insights from psychological research into economics and pioneering the fields of behavioral economics and behavioral finance, and investment and decision-making theory; Mr. Smith was cited for his work in alternatives markets and economic psychology.

Behavioral finance opened a new field of investment theory, challenging foundational concepts of modern portfolio theory widely used in investment management.

In 1985, academics Werner De Bondt and Richard Thaler found predictive value in examining overreaction to unexpected dramatic news events.

Behavioral finance rejected traditional market theories, such as the rationality of investors, the efficiency of markets, and pricing that reflects intrinsic value. “Investors do not behave the way the theories predict,” Mr. Thaler said in a P&I story in 1996.

Behavioral finance seeks to exploit such supposed inefficiencies to outperform the market. It uncovered “cognitive biases that can lead to prices responding irrationally,” said Jacobs Levy's Mr. Jacobs in an e-mail.

Mr. Thaler has applied his theory. In 1998, he joined Russell J. Fuller to create Fuller & Thaler Asset Management Inc. to offer behavioral-based investment strategies.

In 1978, the Connecticut, Utah and Washington state pension funds began securities lending.

The new practice enabled pension funds to earn incremental income on securities in their portfolios from fees paid by borrowers and from investment of collateral from borrowers to secure return of the lent securities.

At the time, corporate pension plans were prohibited from lending their securities, but a year later, what was then Grumman Corp., now Northrop Grumman Corp., won a Department of Labor exemption to do so.

The 2008 financial crisis showed investors took too much risk in investing collateral in longer-term securities that couldn't readily be sold. Investors were exposed to potential losses when trying to call in collateral investments. A number of pension funds sued their custodial banks, which also ran their securities lending programs. Plus, investors modified their programs to emphasize fee income from lending, rather than investment income from collateral investing.

A combination of factors drove corporate pension plan sponsors to derisk their plans.

The primary factors were tougher pension regulations raising contribution requirements; worsening funding ratios caused by pension asset losses of the financial crisis and lower interest rates increasing pension liabilities; and new and potential Financial Accounting Standards Board rules to place more pension finance data in corporate financial statements.

Many sponsors turned to liability-driven investing as a key derisking approach to closely match pension assets to pension liabilities and thereby offset volatility in funding levels.

LDI's origin dates to the 1980s, when interest rates were high. Approaches known as immunization and dedication then used bond portfolios to closely match pension assets and pension liabilities.

In recent years, sponsors have become more concerned about the risk to corporate valuation and cash flow of pension underfunding. More focused on the objective of minimizing underfunding risk than on investments to grow pension assets.

While some sponsors began to put LDI into practice, others hesitated from implementation for two primary reasons. One, interest rates have been low, causing concern that an upswing would damage fixed-income valuation. Two, underfunding left many plans in need of investing in return-seeking assets to raise funding levels, causing them to delay derisking strategies.

Some corporate plan sponsors in North America and the U.K. in recent years have looked to derisk their defined benefit plans, including seeking ways to wind down their involvement. By annuitizing, or buying out liabilities, plan sponsors have sought to transfer to annuity providers the risk of pension plan volatility. The move takes those pension liabilities off corporate financial statements.

General Motors Co. and Verizon Communications Inc. initiated the biggest buyouts of parts of their defined benefit plans in 2012. The moves completely eliminated any obligations by the companies for those liabilities. Each purchased group annuity contracts from Prudential Financial Inc.

GM transferred $26 billion in pension obligations of retirees in its U.S. salaried pension plan. Verizon transferred $7.5 billion for a group of salaried retirees, about 25% of its total pension liabilities.

In addition, to annuity buyouts like GM and Verizon, some sponsors initiated buy-ins. Earlier this year, the Canadian Wheat Board, Winnipeg, Manitoba, purchased an annuity in a pension buy-in from Sun Life Assurance Co. of Canada, that transfers all the plan's C$150 million (US$147 million) investment and longevity risk to Sun Life from CWB's pension plan, according to a P&I story. CWB will continue to administer the plan and make the benefit payments, while Sun Life assumes the investment and longevity risks.

Not everyone is sold on annuitization. If plan sponsors “believe (they) have a better chance of investing the (assets) than the insurance company, there is no reason to do” annuitization, Maggie Ralbovsky, managing director, Wilshire Associates Inc., Santa Monica, Calif., said in a P&I story last year.

Companies might be “giving up the opportunity to earn a better return,” she said.

Outsourcing, an alternative for asset owners to overseeing the investment function internally, hit $995 billion in assets as of March 31 this year on a full or partial discretionary basis, according to a P&I story.

Several factors are behind the origin of outsourcing, or outsourced CIO, said Eric Macy, managing director, fiduciary solutions, Russell Investments, Seattle.

One was recognition by pension funds and other asset owners of their lack of resources and expertise to keep up with the challenges of an increasingly complicated investment market. Also, organizations wanted to focus on their core business, rather than divide attention and resources to oversee pension investment management. By outsourcing, executives could concentrate on governance oversight and strategy, rather than implementation.

Outsourcing has exploded in recent years because asset owners realized their performance was not up to expectations, Mr. Macy said. Volatility of pension funding, for example, has been difficult to control.

Investment management consulting was developed because pension funds and other asset owners needed objective information about money managers. The industry developed as P&I gained its footing, although some pioneering firms offered forms of investment consulting in the 1960s.

In 1969, George F. Russell Jr. moved Frank Russell Co. into strategic pension fund consulting. He pioneered development of “many investment tools and approaches pension funds use today,” according to a P&I story on Oct. 27, 2003.

Consultants serve as influential gatekeepers for pension clients, steering their direction on investments and introducing new asset classes and strategies. They advise on investment policy, asset allocation and implementation. They screen, monitor and recommend managers for hiring and termination. They also serve as fiduciary support for decision-making of trustees.

The consulting industry came under conflicts-of-interest criticism by the Securities and Exchange Commission in 2005 and Government Accountability Office in 2007, as firms provided soft-dollar or directed-brokerage services as well as added money management to increase revenue and attract talent in a business regarded as low margin. Further criticism on objectivity was raised when investment consultants started taking fiduciary control from asset owners as outsourced CIOs.

In the early 1980s, minorities and women first launched money management firms.

In 1983, John W. Rogers Jr., then 24, founded Ariel Investments LLC, the first African-American-owned money management firm.

Mr. Rogers compares the opening of his firm to Branch Rickey signing Jackie Robinson to a contact to play in Major League Baseball in 1947. “Morally it was the right thing to do and it increased the opportunity set” in investment management, Mr. Rogers said.

Also in 1983, Brown Capital Management LLC was founded by Eddie Brown, currently chairman and CEO. In 1981, Eugene C. Sit, a native of China, left as chairman and president of IDS Advisory Services to found Sit Investment Associates Inc.

In 1980, Madeline Einhorn Glick founded MEG Asset Management, becoming “possibly the first woman to successfully branch out with her own investment management firm,” according to a P&I story Dec. 12, 1983. She was an investment manager with BEA Associates.

The adoption of performance presentation standards by what was then the Association of Investment Management and Research (now the CFA Institute), effective Jan. 1, 1993, provided for the first time an objective way to obtain performance data and comparisons for money management firms. Previously, asset owners faced challenges obtaining a fair representation of investment performance.

Managers were encouraged to comply and, while not mandatory, verify compliance, using an independent firm to attest to compliance.

The acceptance of PPS led AIMR to propose global investment performance standards, introduced in 1999. This year, the CFA Institute issued an exposure draft for the application of GIPS to pension funds, endowments, foundations and other asset owners that do not generally compete for money management business.

EBRI was founded in 1978 to conduct research on employee benefit plans. In the retirement area, EBRI initially concentrated on defined benefit plans, later adding defined contribution plans.

Its founding principle is that “employee benefit plans serve an essential function in the United States economy by providing citizens with opportunities to achieve financial security.” EBRI, which does not lobby or take any advocacy role, fills a need for objectivity in employee benefits research to contribute to creating better public policy on retirement programs.

EBRI wasn't the first and isn't the only such thriving center. Dan M. McGill, as a new member of the faculty of the Wharton School of the University of Pennsylvania, founded in 1952 the Pension Research Council, becoming its director. The pioneering academic center at the Wharton School “brought into light the corporate pension industry just as it was forming into the modern system it has become,” P&I reported in March 2013.

The Center for Retirement Research at Boston College was founded in 1998 by Alicia M. Munnell, Peter F. Drucker Professor of Management Sciences at Boston College's Carroll School of Management, a former senior vice president and director of research at the Federal Reserve and former assistant treasury secretary for economic policy.

In 2005, the Rotman School of Management at the University of Toronto created the International Centre for Pension Management, a global pension research center. The school named Keith Ambachtsheer as the center's founding director. Mr. Ambachtsheer, president of KPA Advisory Services, was also named an adjunct professor of finance at Rotman.

In 2007, three pension fund organizations — the Council of Institutional Investors, National Association of State Retirement Administrators and National Council on Teacher Retirement —created the National Institute on Retirement Security.

They dedicated NIRS to conduct research and education programs “to foster a deep understanding of the traditional pension system in the U.S.”

Early scandals linked some union pension plans with financing projects for organized crime. In the 1950s, the Central States Teamster pension fund helped finance construction of hotels and casinos in Las Vegas. In 1975, the fund financed a Connecticut gambling facility for World Jai Alai, which was backed by organized crime, specifically Boston's infamous Winter Hill Gang, according to testimony of Austin McGuigan, former Connecticut chief state's attorney in a 2002 hearing before the U.S. House Committee on Government Reform. In 1976, the Internal Revenue Service moved to rescind the pension plan's tax-exempt status due to corruption, leading the fund in 1977 to hire a managing fiduciary to clean it up.

Also in 1977, the Labor Department sued the Southern Nevada Culinary & Bartenders Pension Trust to stop a $31 million loan to Morris Shenker, a controversial real estate developer. Around the same time, Al Bramlet, a pension fund trustee and secretary-treasurer disappeared. Mr. Bramlet had reportedly been fighting with Mafia dons over his cut of profits to be skimmed from the use of pension assets to set up a clinic to treat union members. His body was found buried in the desert outside Las Vegas two weeks later.

Institutional capital got snagged into everything from Michael Milken's junk bond exploits to Ivan Boesky's insider trading and Bernard Madoff's elaborate Ponzi scheme. The Orange County bankruptcy in the 1990s led the Orange County Employees Retirement System, Santa Ana, Calif., to boot the county treasurer from controlling its pension funds and to hire an independent auditor instead of relying exclusively on the county auditor-controller's annual audit.

More recently, alleged insider trading at S.A.C Capital Advisors has led to pension fund lawsuits as well as criminal prosecution of the hedge fund.

Since ERISA's passage, more and more lawsuits have been brought by plan officials against money managers, advisers and consultants alleging breach of fiduciary duty. Many were sparked by scandals such as insurance company Executive Life, a subsidiary of First Executive Corp., which had a substantial amount of its guaranteed investment contracts and annuities it sold to companies terminating their defined benefit plans backed by junk bonds.

The first lawsuit against First Executive was filed by retirees of Pacific Lumber Corp., which had been acquired by Maxxam Inc. in 1989. Maxxam had partly financed the acquisition with junk bonds it sold to Executive Life. Maxxam then terminated Pacific Lumber's pension plan and bought annuities for the retirees from Executive Life.

In 1991, insurance regulators froze Executive Life's annuity payments and GIC contracts.

More recently, many lawsuits stemmed from pay-to-play scandals involving private-placement agents that peddled investments to pension funds on behalf of money managers. Impacted were the New York State Common Retirement Fund, CalPERS, New Mexico State Investment Council and New Mexico Educational Retirement Fund.

On the defined contribution side, there has been a rash of suits over everything from the fees providers charge to issues with company stock options.

A number of firms have been cthe subject of lawsuits filed by plan participants claiming breaches of fiduciary duty related to offering a company stock option. This month, the U.S. Supreme Court declined to hear two cases involving company stock by participants in plans sponsored by Citigroup Inc. and McGraw-Hill Cos. in which participants claimed the companies had misled them about their defined contribution plans' exposure to subprime mortgage losses through their company stock investments.

Asset owners participate both as active leading litigants and as passive investors seeking claims in class-action settlements. The impetus was the Private Securities Litigation Reform Act of 1995, encouraging institutional investors to take the lead in such litigation, previously initiated mostly by individuals.

Asset owners' involvement has contributed to higher settlements and lower attorney fees.

The first widely applied divestments by institutional investors involved South Africa because its apartheid laws mandated racial segregation.

Sullivan Principles, created in 1977 by the Rev. Leon Sullivan, then a General Motors Corp. board member, sought to put economic pressure on South Africa for its discrimination policies.

In the late 1970s, university endowment funds divested, responding to calls by students.

At least 27 states, 88 cities and 24 counties had laws or policies restricting business or investment ties to South Africa in 1992, according to a P&I story at the time.

But some pension executives viewed divestment as a violation of fiduciary duty. Investors ultimately dropped their South Africa divestments following the dismantling of apartheid.

Divestment campaigns have grown over the years to include tobacco, Northern Ireland and calls for adoption of the so-called McBride Principles on fair employment practices. In addition, some states directed divestment of companies doing business in Sudan and Iran over their support for terrorism.

Most recently have been divestments in gun manufacturers and retailers by some public pension funds following the fatal shootings last year at Sandy Hook Elementary School in Newtown, Conn., and some public officials have called for divestment in companies involved in producing or distributing fossil fuels.

The founding of the Council of Institutional Investors in 1985 marked the beginning of institutional shareholder/corporate governance activism. The founders were a group of 21 officials from public funds as well as one corporate fund. That was “a time of corporate takeovers, imperial CEOs and insulated boards of directors,” CII notes in a statement of its history.

Today, many of the corporate governance policies CII promoted and once considered radical are commonly accepted, the council said in its statement.

Other asset owners and managers have come to embrace shareholder activism, stepping up engagement with companies. Activist hedge funds, which typically concentrate portfolios in a few companies, take institutional activism further by seeking to improve performance through influencing operational, structural as well as governance changes.

Investing institutional assets to stimulate a region's economy or to make plans more socially responsible began in the early 1980s and has become an integral part of mainstream investing for some asset owners.

Early on, institutional investors eschewed socially responsible investing, concerned it could run afoul of their fiduciary duties because investment performance was not a primary aim.

SRI began to gain more appeal as it transformed from a traditional negative screening approach to positive screens to uncover investment opportunities, and stressed the objective of generating long-term competitive returns.

SRI most recently broadened to focus on environmental, social and governance issues, emphasizing that the long-term sustainability of an investment depended on its good practices in all three areas.

In 2006, the United Nations Principles for Responsible Investment were unveiled. They are a set of six voluntary global guidelines embracing the idea that “ESG issues can affect investment performance and that the appropriate consideration of these issues is part of delivering superior risk-adjusted returns and is therefore firmly within the bounds of investors' fiduciary duties.”

Since then, 271 asset owners and 754 money managers have signed the UN PRI.

Former Secretary of Labor Robert Reich outlined a plan in September 1994 for pension plans to do well by doing good, known as economically targeted investments. The plan was to create “a new ethic of stewardship” in which the pension funds would search for investments that not only provided above-average returns, but also boosted the local economy as a collateral benefit.

More than 29 state pension funds have ETI programs. Many, including Michigan, New Mexico and Washington, have private equity and venture capital programs aimed at bolstering growth of in-state companies.

Most recently, in February, the New York City pension funds invested about $500 million in residential and commercial real estate in areas affected by 2012's Superstorm Sandy. With leverage, it is anticipated that this would amount to $1.5 billion in capital.

It all started with Wall Street's infamous 1975 “May Day,” when the SEC abolished fixed commissions for brokerage trades, instead leaving it to market competition to set pricing. This allowed brokerage fees, which had been kept artificially high by a small cabal of brokers, to drop.

More than two decades later, the markets converted to decimal pricing, further pushing down the price of trading securities. In 2005, P&I reported trading costs for institutional investors had declined by as much as 53% for NYSE stocks and 44% for Nasdaq stocks from the previous year.

Meanwhile, computing power drove the creation to today's souped-up version of trading — high-frequency program trading — which has increased volatility in the equity markets and caused dislocations in the markets, Towers Watson's Mr. Ali said.

Despite serious technical glitches, such as on Aug. 22 when Nasdaq suffered a three-hour trading halt, trading is expected to keep getting faster and more secret as more managers trade big blocks of securities in so-called dark pools, in which the trades are disguised.

These developments are blurring the lines between tactical short-term decisions and strategic, long-term decisions, Mr. Ali said.

Pension obligation bonds have helped governments continue to support their pension plans, but have had a checkered history.

The Tax Reform Act of 1986 eliminated the tax exemption on municipal POBs. Nevertheless, POBs again began to be issued in bulk partly because the stock market had gone up and pension funds had increased their equity investments, so they saw an arbitrage opportunity. POBs only pan out for all involved if the pension fund's returns exceed the borrowing rate, thereby reducing future sponsor contributions to the pension plan.

The first was issued in 1985 by Oakland, Calif.; between 1986 and 2009, governments issued a combined $53 billion in pension obligation bonds, according to the Center for Retirement Research at Boston College.

The bonds lost their appeal for some investors because the interest rate offered often is more than the pension fund's investment return. Indeed, pension obligation bonds have been fingered as a contributor to the Chapter 9 bankruptcies of Stockton, Calif., and Detroit.

Fads have come and gone in institutional investing. Some had a huge impact, while some faded away, never meeting expectations.

One of the biggest was portfolio insurance or dynamic hedging. Its impact was big not only on investors that used it, but also on all market participants.

In 1981, Leland O'Brien Rubinstein, began offering portfolio insurance, under which investors would use a computer program LOR developed to sell equity and raise cash as stock prices fell, protecting portfolios from market loses. When stock prices began to recover, they would begin to buy equities back to their asset allocation. The SEC said portfolio insurance worsened the Oct. 19, 1987, market crash and led to the strategy's demise.

In the years approaching 2000, fears arose about computer glitches that could set up economic and market turmoil because the turning of the millennium — or Y2K — would trigger confusion in dates due to a practice of using two digits to represent years. But the new year came without the disruption many had forecast.

In the 1980s, companies recaptured surplus pension assets through plan terminations. High interest rates raised funding levels, which lured plan sponsors as well as corporate raiders to terminate plans so they could take the assets not needed to pay benefits. Companies took different approaches.

Excess pension assets made companies takeover targets. Some corporations, realizing their vulnerability, either stepped in with their recaptures or used their pension surplus as an anti-takeover device, called a pension parachute. Under such a defense, in the event of a hostile takeover, the excess assets would revert for use to raise pension benefits.

All the activity of excess revision attracted concern in Congress about the security of retirement benefits.

In 1990, Sen. Howard Metzenbaum, D-Ohio, led passage of legislation that made terminations unattractive by imposing excess taxes and other conditions on recaptured assets.