Pension Funds Have Moved to Alternative Assets. Was That a Good Idea?
With many public pension funds still trying to recover from investment losses incurred during the Great Recession a decade ago, there has been a greater emphasis on so-called alternative asset classes, including commercial real estate. In fact, on average the funds’ allocation to alternatives nearly tripled over a 15-year period, from 10% in 2001 to around 30% in 2016.
Over that same time period, the annualized returns for most of the alternatives have outpaced those of the stock market. Among the best-performing funds, for example, real estate allocations have posted 10.2% annualized returns, compared to 6.2% for public equities.
However, Kroll Bond Rating Agency (KBRA) says, the question is whether this shift in allocations has paid off for pension funds. “For the moment, the jury is still out,” KBRA says in a research report.
KBRA notes that results can vary greatly by fund. Citing a study by Boston College’s Center for Retirement Research, the rating agency says that funds with the greatest shift in allocations to alternatives have tended to be the weakest performers over a 15-year period.
During that period, says KBRA, “there was a 1.7% difference in total return between the top and bottom quartiles” of pension funds ranked according to their investment performance.
“The divergence in returns is due to differences by asset class,” according to KBRA. “Performance for fixed income portfolios was virtually the same across all funds, while the bottom quartiles lagged the top-performing quartiles in equities and alternatives.”
Other variables come into play. These include external management fees and the performance of outside investment managers.
There’s also the subdivision of asset classes into subcategories. “Private equity,” for instance, could mean private equity buyout, private equity growth, private equity real estate or all or none of the above.
“Each subcategory introduces different levels of risk and potential returns, and at different points in the market cycle will enjoy varying levels of success,” says KBRA. “As pension managers allocate assets to alternative investments, it is critical to prudently assess those subsegments, and consider market conditions that could influence the performance of those strategies over longer periods.”
For comments, questions or concerns, please contact Paul Bubny
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