State pension plans are receiving little in excess returns from their public equity managers, one reason pushing those plans into increased allocations to alternative investments, a new report from alternatives investment consultant Cliffwater LLC concludes.
The annual report, “State Pension Performance and Trends,” concludes that state pension plans have not succeeded in picking active stock managers during the 10 years ended June 30, 2012.
For the 97 pension systems studied, the median excess return over the Russell 3000 index for U.S. equity was zero for the 10-year period. International stock returns for those pension funds were 10 basis points over the MSCI ACWI ex-U.S. index.
The lack of excess return is a combination of pension funds shifting more to passive strategies and making poor manager selections, said Stephen Nesbitt, CEO of Cliffwater, Marina del Rey, Calif.
“U.S. equity has been a struggle in terms of selecting active managers,” Mr. Nesbitt said. “It's hard to find good long-term performance.”
Pension funds in the top decile of domestic equity saw just 70 basis points of excess returns, for example, while the bottom decile did 90 basis points worse than the index.
The top and bottom deciles for international equity were 1.2% and -1.3%, respectively.
On the flip side, fixed-income and private equity managers showed consistent outperformance during the 10-year period. The median excess return for bonds was 0.6% over the Barclays Aggregate and the top and bottom deciles were 1.8% and zero, respectively.
The median excess private equity return over the Russell 3000 was 5.1%. The bottom decile actually had 0.2% of underperformance but the third quartile was still up 3.3%. Real estate had a median 0.9% of underperformance over the NCREIF Property index, but was up 1.2% in the top decile.
The lack of excess returns in equity supports Cliffwater's view that higher allocations to alternatives, and selecting the right managers, results in better returns. Over the 10-year period ended June 30, 2012, global stocks and U.S. bonds generally had the same annualized performance, at 5.73% and 5.64%, respectively, meaning the stock/bond mix has had little influence on returns, Mr. Nesbitt said.
State pension plans earned a median 10.9% on private equity and 7.7% on real estate over the 10 years, surpassing the median 6.4% total return, which is well below the average 8% actuarially assumed rate of return.
“It's really a continuation of the major trends from last year, such as continued allocations to alternatives,” Mr. Nesbitt said. What has changed from prior years is that pension plans are taking more out of fixed income to fund alternatives than before, Mr. Nesbitt added. The shift had largely come from equities.