Taking higher risk in investment portfolios should generally over the long term provide investors with higher returns, but no rule guarantees that every investor will earn those higher returns and nothing specifies what the longer term is.
Therefore, investors should be aware that when they take on more risk, they might have to wait longer than expected for that higher return. And not every high-risk investment will pay off; some might drive down the returns, so they might never see higher returns.
State and local pension funds are relearning those facts of investment life now, according to a report from Fitch Ratings. According to the report, state and local pension funds increased their risk profiles by hiking their average exposure to equities and alternatives to 77% in 2017 from 67% in 2001. However, the median annual rate of return dropped to 6.2% in the longer 2001-2017 period, from 6.4% for the period from 2008 to 2017.
That is, the increased exposure to higher risk assets did not automatically boost fund returns.
There are several possible reasons for this: The period might have been too short for the higher-risk assets to pay off; the funds might have chosen the wrong stocks or alternatives, ones that performed poorly; or the assets might have provided increased returns, but not enough to offset the higher fees they required.
It's a timely reminder for all investors, institutional and individual: Higher risk does not guarantee higher return.
And funds relying on higher-risk portfolios to dig out of a funding hole instead of seeking more contributions might find themselves digging deeper holes.
