STUMP » Articles » Public Pensions Watch: Alternative Asset Classes, pt 5 of many, Some Boosterism » 6 September 2014, 01:58

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Public Pensions Watch: Alternative Asset Classes, pt 5 of many, Some Boosterism  


6 September 2014, 01:58

I will be getting back to tales of Alternative Asset woes in public pensions, but let’s take a break for some boosterism.

After I had written parts 1 – 4 of this series, I came across this article ranking state pension fund performance

The latest research from Cliffwater, a Los Angeles-based alternative asset consultant to institutional investors, claims the best-performing public retirement funds have above-average allocations to alternative asset classes.

The top 25 performing funds over a 10-year annualized period had an average allocation of 29 percent to alternatives, according to Cliffwater. By comparison, the average allocation to alternatives was 25 percent for all public pension funds.

The one notable exception to the trend was the Oklahoma Teachers retirement fund, which happens to be the top-performing fund on Cliffwater’s ranking after posting a 10-year annualized return of 8.8 percent. Cliffwater’s analysts said the selection of traditional managers accounted for the fund’s performance.

There is no arguing institutional investors’ growing interest in alternatives in recent years. Last year, state pension funds added another 1 percent to alternatives, mostly moving money from fixed-income.

In 2006, the average public fund allocated a mere 10 percent to alternatives, significantly lower than today’s average.

Of course, why did they need alternatives then, when they had their AAA-rated structured securities filling out their bond portfolios? And regular equities were going great guns?

Which all fell apart in fall 2008.

I will pull out two that specify a relatively high amount of alternative assets:

4. Missouri State Employees Retirement System

10-year annualized return: 8.4 percent

The Missouri State Employees Retirement System fund oversees more than $8 billion. Its website says that its alternative allocation (24.1 percent) was almost equal to its public equity allocation (25 percent).

9. Massachusetts Pension Reserve Investment Management Board

10-year annualized return: 8.1 percent

Private equity, hedge funds and real estate investments each occupied 10 percent of the allocation pie in the Massachusetts retirement system funds, as of the latest data in 2013. Including 4 percent holdings in natural resources, that puts alternative assets at roughly 34 percent. The funds oversee $60.6 billion in assets.

I do want to make something clear: “alternative” assets are not, in and of themselves, scams or even necessarily inappropriate for pensions.

However, there are aspects that make them questionable for use in public pensions, especially in states with a long history of official corruption and also in states where the funded position is poor. It is also very questionable when such high percentages are allocated to these asset classes.

The whole point of the assets being “alternative” is that there is no broad, liquid market in these assets, and in the case of many of the hedge funds and private equity funds, investors are restricted from removing their investments for a certain period of time.

This makes a certain amount of sense, but if one must have cash flow paid to pensioners, you can see how this can become a problem if the pension plan can’t even liquidate a large percentage of its supposed assets.

The point is that investing in alternatives requires more sophistication and a lot more investment discipline than using market-traded stocks and bonds.

When it goes well, it can be a boon to the funds, but when it goes poorly, it can be disastrous.

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