Searching for higher returns, a hedge against other investments risks and diversification, public pension funds have boosted their alternatives allocations over the last 10 years, said a recent report from the Center for Retirement Research at Boston College.
Starting with data from the Public Plans Database, which shows that state and local pension plans' allocation to alternatives rose to 24% in 2015 from 9% in 2005, the CRR set out to find what types of plans allocate more to alternatives and how alternatives affected portfolio returns and volatility. The types of alternatives investments examined were private equity, hedge funds, real estate and commodities.
In regards to the first question, the CRR found that while plans with an above-average assumed rate of return and plans that started investing in alternatives before the recession are estimated to hold 5.7% and 11.5% more in alternatives, respectively, "few plan characteristics are related to holdings of alternatives" and "plans of all types have been drawn to alternative investments." Other plan characteristics examined included plans with negative cash flow, plans with a separate investment council and plans with above-average funding ratios, did not show anything statistically significant.
Regarding returns, the report found that "a 10% increase in the average allocation to alternatives was associated with a reduction of 30-45 basis points, primarily due to hedge funds."
Regarding volatility: "Alternatives did not have a statistically significant effect. Hedge funds reduced volatility, but real estate and commodities increased it."
The full report is available on the CRR's website.
The CRR notes that its report should be viewed as preliminary and does not examine individual plan performance, but rather the performance of public plans in aggregate. The CRR further acknowledges that its report does not address the extent to which alternatives helped meet an individual plan's objectives and does not address fees, disclosure or administrative issues.