STUMP » Articles » Alternative Assets and Pension Performance: A Dive into Data » 3 May 2018, 12:35

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Alternative Assets and Pension Performance: A Dive into Data  


3 May 2018, 12:35

As promised in a prior post, I’m going to be digging into the many dimensions that drive public pension deteriorating status.

I have a news hook for this:

Pa. treasurer says ‘we have seen this movie before’ as pension system shifts toward costly hedge funds:

Pennsylvania’s $30 billion state pension fund — the State Employees’ Retirement System (SERS) — made so much money in the stock-market boom over the last few years that it will cut taxpayers’ “employer contribution rate” for the first time since 2010, while still boosting total assets.

Does that mean it’s time for changes in strategy?

SERS’ investment assets rose to 61 percent of the state’s long-term pension liabilities in 2017, from 56 percent the year before. That will help SERS go ahead with a projected cut in state pension contributions, to a 32.9-cent surcharge from taxpayers, on top of every dollar paid to a group of state workers in fiscal 2018-19, down from 33.2 percent this year, without weakening the plan.

Cutting in here for a second: 61 percent funded is awful. Do we all understand that? Okay, moving on:

But SERS isn’t waiting for the stock market to repeat that extra-strong performance. Instead, it’s pulling back on stocks — and bonds — to invest more in real estate and “private equity” corporate buyout funds like the ones managed by Sixers owners Josh Harris (Apollo Global) and Steve Schwarzman (Blackstone). This reverses a recent trend toward SERS buying more cheap stock and bond-indexed investments.

The switch angered State Treasurer Joseph Torsella, who responded Friday with a statement condemning SERS’ recent investment focus: “I am deeply troubled by SERS’ new asset allocation strategy that will result in an extraordinary 38 percent of total fund assets in illiquid, high-risk, and exorbitantly high-fee ‘alternative’ investments,” he said. “This would be a significant increase from the already high level of 30 percent currently, and would be higher than 85 percent of US pension funds. For a system that has made significant progress recently, this decision will be a real step back.”

Well, let’s check how high this actually is, compared to other pension plans.


I had this plot in the prior post:

Last time, I didn’t explain what you were looking at, and now I will tell you: I graphed the percentage allocation to alternative assets (as defined in the Public Pensions Database) – this is a box-and-whisker plot.

A box-and-whisker plot provides some important stats on the underlying data — the box with a line inside delineates where the 25th percentile, median (50th percentile), and 75th percentile land for that set of data. Then whiskers are extended from that box based on that “interquartile width”, capturing some tail data that are considered “reasonably” in the tail.

The data points beyond the whiskers are considered extreme.

So “reading” this graph, we see that overall, allocations to alternative assets has been rising, especially in the last decade.

Focusing solely on FY2016, the median allocation to alternatices was 16%.

The 75th percentile was 25%.

38% falls about at the 92nd percentile (going from the data I had).

And 30% is around 85th percentile – it’s a little higher than that, but it’s below 90, so close enough.

So yes, the proposed allocation is very high, at least compared to peers.


Let’s go back to the article for more problems with alternative assets:

Real estate, private equity, and hedge funds charge higher fees — 1 to 2 percent of assets invested or more per year, plus a cut of profits above certain targets — though in SERS’ case, it’s hard to tell how much profit investment managers keep for themselves. That’s because SERS declines to report that total, unlike the larger Pennsylvania Public School Employees’ Retirement System (PSERS) or the Philadelphia Board of City Pensions, which have begun reporting managers’ retained earnings and the fees they collect.
Earlier this year, SERS transferred $200 million from indexed investments to hedge funds. The new Investment Report projects much larger transfers in the same direction. SERS’ updated asset allocation policy, approved by the board Wednesday, “provides a prudent blueprint to continue to meet the long-term liquidity needs to pay benefits and covenants in various market environments,” said spokeswoman Pamela Hile. She said it was important for the plan to “diversify” investment assets and be ready for possible “difficult market conditions.”

Treasurer Torsella sits on the 11-member SERS pension board, but he is outvoted by legislative appointments who back the new strategy. The board’s chairman, David R. Fillman, is a leader of AFSCME District Council 13, whose members receive SERS pensions. Workers’ payroll deductions help finance SERS, but most of the system’s funding comes from direct taxpayer contributions and investment returns.

Comparing the recent record of Montgomery County’s pension system, which only invests in indexed funds, with those like SERS that also buy private investments, it’s unclear that either approach has yielded consistently higher profits.

But Torsella and other critics have linked private investments, not only with mediocre returns, but also with conflicts of interest and corruption, given the huge that profits private money managers can enjoy. Two of Torsella’s three immediate predecessors, former Treasurers Rob McCord and Barbara Hafer, pleaded guilty to criminal charges in connection with cash they were paid by firms trying to win state investing contracts.
“We have seen this movie before in Pennsylvania, and it did not turn out well for retirees and taxpayers,” the treasurer added. “The losses SERS was forced to realize in 2008 are part of the reason the fund only has under 60 cents for every dollar it will need for future payments to retirees.”

He called it a “deeply flawed assumption” to expect state investment consultants to “reliably pick winners and losers,” and added that most SERS hedge-fund and private equity managers “underperformed their benchmarks” despite their “secretive, complex, and illiquid” investment formulas and fees adding up to hundreds of millions of dollars a year.

He’s not wrong about the big loss suffered by the plan. Check out this graph:

From 2007 – 2008, there was a drop of $35.5 billion to $22.8 billion. A drop of over 35%.

There are all sorts of problems with this pension fund, btw:
- Many more beneficiaries than active employees
- Crazily increasing contribution rates, linked to grossly undercontribution history
- Underperformance in returns.

You can check it out for yourself. (I’m not doing a profile right now)

I think the Treasurer is right to question this strategy.


I’m going to do a quick draw of the data right now, looking at the alternative asset allocation percentage against the investment returns over different time horizons. I’m only looking at the allocation to alternatives in FY2016, and looking back.

Let’s start with the oddest of the graphs: the one-year return

You see there’s a dichotomy in the graph… but that’s really easy to explain. The data are gathered by fiscal year…. but not every state/municipality have the same fiscal calendar. Some base it off the calendar year, and many base it off a July 1 – June 30 calendar. It could be any start/end date they want. I’m assuming this dichotomy comes from this half year shift.

But we weren’t planning on making any inferences off of 1-year returns, were we? That’s so short term. By the way, the big blue square is the overal average for the data.

I also did a linear fit, just to get the general correlation. It’s not high, obviously, in a bifurcated data set like this.

Let’s look at 5-year returns:

Okay, now we’re cooking. Those half year differences get smeared out, the farther out you go.

Ten-year returns:

Observations: in each case, I end up with a negative sloping line, meaning higher allocations to alternatives are associated with lower returns. Part of this is due to the outlier of Dallas Police and Fire, with its super-high allocation to alternatives, and its disastrous investment history.

But even removing that point, I’d end up with a negatively sloping line….

….but that said, check out those R^2 stats.

Those are really low.

So, no, high use of alternatives definitely is not related to great investment returns….
….but it’s not really indicative of crappy investment returns, either.

If there is any causal direction, I would think it would be plans which were underperforming seeking to make up for crappy experience in the past (rather than the alternatives driving the crappy performance.)


Given the extra risk inherent in these funds, are pension plans being adequately compensated for these asset risks they’re taking on?

If you’re not getting extra returns, or even hedging returns, from the alternatives… what are you doing with them? Just fooling yourself you can generate alpha?


Here’s yet another hook, from Ted Siedle.

100 Questions You Should Ask Your State Or Local Pension

Sometimes a list of penetrating questions can be more damning than the answers. And when politicians either cannot answer questions posed by the public (because they don’t know the answers) or will not (because they don’t want to confess their sins), then the list of unanswered questions speaks volumes.

No, I’m not talking about The New York Times recently published list of over 40 questions special counsel Robert S. Mueller III wants President Trump to answer about obstruction of justice.

What I’m talking about is a list of 100 sophisticated questions an association of retired teachers sent to the politician running their state pension regarding lack of internal controls related to the high-cost, high-risk, opaque hedge, venture and private equity investments that had already cost the pension billions in underperformance losses.

These retired teachers had their retirement benefits slashed in recent years due to pension mismanagement and learned that if they didn’t get actively involved in safeguarding the state fund, additional benefit reductions would likely be forced upon them.

Lesson learned: Absent vigilance, there can be no retirement security.

In my expert opinion, all Americans across the nation—all stakeholders in our public pensions—would be well-advised to follow in the footsteps of these retired educators. (Full disclosure: I assisted in composing their list of concerns.)

You can read his whole column, and also read the full document

RIRTA DOC 2 by forbesadmin on Scribd

I will pick out a couple questions:

A. 50 Questions Related to Treasurer’s “Back to Basics” Plan
11. When did the investment consultant disclose to the SIC [Rhode Island State Investment Commission] were highly speculative investments? Please provide any documentation.

12. When did the investment consultant disclose to the SIC that hedge funds are designed only for sophisticated investors able to withstand a total loss of their investment? Please provide any documentation.

17. When did the investment consultant disclose to the SIC that hedge funds may engage in unlimited leverage? Please provide any documentation.
26. On a 1, 3, 5, and 10-year and from inception basis, by how much have the hedge funds underperformed from the public equity indices?

27. How much has this underperformance cost the pension on a 1, 3, 5, 10-year and from inception basis?

C. 10 Questions Regarding Valuation Uncertainties

1. What percentage of pension assets is Level 1, based upon quoted price in active markets?
2. What percentage of assets is Level 2, based upon significant other observable inputs?
3. What percentage of pension assets is Level 3, limited liquidity and hard to value?

Let me explain those last three. That’s from the concept of fair value — specifically, as applied in the USA.

Alternative assets tend to be Level 3 assets, meaning they are very hard to value – and while there is interim reporting, it’s not until you get all the cash out that you actually know how the value has performed.

Anyway, the full list of questions is comprehensive.


I am not against alternative assets in general, but if one is a fiduciary, one needs to understand the nature of what you’re agreeing to have pension money being invested in.

And then there’s the matter of how much you’re putting at risk.

A small allocation to alternatives, say 5%, is not necessarily concerning.

A 40% allocation is very concerning.

It doesn’t seem that alternatives have actually shown any boost to returns to the plans that have used that as a big part of their strategies… and given the hard-to-value nature of these investments, one may not know how they really did until a decade later.

One can be a long-term investor and lose a heck of a lot of money very rapidly with some of these asset classes.

Is that what one wants to do with pension funds?

Underlying Data for Figures
Figures from Paper, in Word Doc

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