U.S. public pension plans' increasing allocations to alternative investments over the past 20 years have not helped overall returns, although they may have helped reduce volatility, according to a new brief from the Center of Retirement Research at Boston College.
The brief — "Public Pension Investment Update: Have Alternatives Helped or Hurt?" — was published Tuesday and poses the question as a result of the negative returns of U.S. public pension funds for the fiscal year ended June 30.
Author Jean-Pierre Aubry, associate director of state and local research at the CRR, said in the brief that sources have cited the exposure to alternative investments as a primary driver of why the negative returns were not worse.
"But focusing on the short-term impact of specific asset classes ignores the fact that public pensions are long-term investors," Mr. Aubry wrote. "The key question is: have alternative helped or hurt pension funds' long-term investment performance?"
According to the brief, state and local pension funds have increased their aggregate allocations to alternatives to 34% in 2022 from 9% in 2001. The brief splits alternatives into real estate, private equity, hedge funds and commodities and said the distribution of alternative investments in state and local plans in 2001 was 56% real estate, 38% private equity, 4% hedge funds and 2% commodities. In 2022, that split was 34% each private equity and real estate, 18% hedge funds and 14% commodities.
The brief tests the relationship between alternatives allocations and performance by using regression analysis to study three periods: 2001 to 2009 (before and during the global financial crisis), 2010 to 2022 (post-crisis), as well as the entire period of 2001 to 2022.
"The results show that, relative to traditional equities, holding 10% more of the plan's portfolio in alternatives is associated with a 66-basis-point increase in the portfolio return from 2001 to 2009 and a 33-basis-point decrease in the return from 2010-2022," Mr. Aubry wrote. The result, he wrote, is that alternatives have no "statistically significant impact on returns when looking over the whole period from 2001 to 2022."
However, while alternatives did not have any effect on the volatility of pension fund's annual returns in the pre-crisis period (2001 to 2009), they have experienced significantly less volatility in the period after the crisis. From 2001 to 2009, the estimated effect of a 10% increase in average allocations to alternatives caused volatility to increase 6.9 basis points, and from 2010 to 2022, volatility fell 48.1 basis points, and the combined drop in volatility for the entire period of 2001 to 2022 fell 41.4 basis points.
The brief is available at the Center of Retirement Research's website.