The latest Greenwich Associates report on large pension funds contained several interesting statistics that suggest the maturity and sophistication of U.S. pension, endowment and foundation executives.
First, they expect to increase the amount of equity assets indexed. Second, more are willing to consider using hedge funds. Third, even though small-cap and international equities have underperformed the U.S. equity market, and the executives expect international equities to lag for the next five years, they expect to maintain or even increase their commitments to these areas.
The increase in indexing suggests a belief that it is very difficult for most money managers to produce excess returns large enough to offset active management fees.
They therefore are reducing the active portions of their portfolios, reducing the level of risk to that of the market, and reducing management costs.
They are also considering increasing their exposures to hedge funds, despite disasters including the collapse last year of Long-Term Capital Management LP.
The Greenwich Associates survey shows the percentage of pension executives using hedge funds, or willing to consider them, has increased to 11% from 9% for corporate funds, and to 8% from 7% for public funds.
The possible increase in hedge fund usage suggests pension executives believe this is one possible source of excess risk-adjusted returns. However, increasing hedge fund use would increase both risk and management fees, offsetting the indexing.
That might not be a bad tradeoff; but pension executives must insist on seeing the internal workings of any black boxes the hedge funds use. Or they must ensure they fully understand, and do appropriate due diligence on, any hedge fund management firm they use. ERISA demands it. Common prudence demands it.
That more pension executives are willing to consider hedge funds suggests they are less easily spooked by short-term failures. In addition, pension executives are sticking with small-cap and international investing, even though those asset classes have underperformed in recent years. They apparently have decided either that these asset classes will eventually produce superior returns, or that the risk reduction from diversifying into them makes such moves profitable.
The evidence suggests most pension executives are making such decisions on the basis of careful analysis of the likely long-term risk and return prospects.
And once they adopt a long-term investment strategy, they are not allowing short-term developments or trends to dissuade them from it.