Alternative Assets and Public Pension Plan Performance (WP 2008-2)

Abstract

As public pension plans steer more of their portfolios toward alternative assets such as hedge funds, private equity funds, and real estate, we examine how these investments have affected public pension plan performance. We find somewhat mixed results. When compared to pension plans with smaller allocations, public pension plans with at least 10 percent of their assets allocated to alternative investments had significantly higher annual returns in 2004, 2005, and 2006. However, these same plans had lower returns, though not significantly so, in 2002 and 2003. We also find that pension plans that began investing in alternative assets as early as 2001 did not significantly outperform pension plans that began investing in these assets after 2001. This result suggests that much of the performance benefit of alternative assets may be due to superior returns over just the past three years. Turning to risk, we find that pension plans that invested in alternative assets, regardless of the size of the allocation, had significantly higher standard deviations in their returns over a five-year period relative to other pension plans. Measuring risk-adjusted returns with the Sharpe Ratio, we find no significant differences between pension plans that invested in alternative assets and those that did not.

We also explore whether hedge fund investments in particular affected performance. Because hedge funds are new investments for public pension plans and only a few plans invest in them, we need more seasoned data before being able to come to any strong conclusions regarding the effect of hedge funds on pension plan performance. However, based on our current data, we found no significant difference in investment returns for public pension plans with hedge fund investments in 2006.

Authors

Douglas Robertson and Ellen Wielezynski