State Public Pension Funds Increase Use of Complex Investments

Source: Pew Charitable Trusts, April 2017

From the overview:
State and locally run retirement systems currently manage over $3.6 trillion in public pension fund investments, most of which are held by states. Broadly, half of these assets are invested in stocks; a quarter in bonds and cash; and another quarter in what are known as alternative investments, such as private equity, hedge funds, real estate, and commodities.

Although governments and employees contribute to pension funds, investment earnings on plan assets are expected to pay for about 60 percent of promised benefits. In a bid to boost investment returns and diversify investment portfolios, public pension plans in recent decades have shifted funds away from low-risk, fixedincome investments such as government and high-grade corporate bonds. During the 1980s and 1990s, plans significantly increased their reliance on stocks, also known as equities. And over the past decade, funds have increasingly turned to alternative investments to achieve investment return targets.

Greater investment in equities and alternatives can provide higher financial returns but also bring heightened volatility and risk of shortfalls. Most funds exceeded their investment return targets during the bull market of the 1990s but then suffered losses during the volatile financial markets of the 2000s—leading to higher pension costs for state and local budgets. The volatility inherent in public funds’ investment strategies can be seen in more recent results as well, with large funds posting fiscal year gains of over 12 percent in 2013 and 17 percent in 2014, but only 2 percent in 2012, 4 percent in 2015, and 1 percent in 2016.

The shift toward more complex investment vehicles has also brought higher investment fees. State funds reported paying more than $10 billion in fees and investment-related costs in 2014, which amounted to their largest expense. Those fees, as a percentage of assets, have increased by about 30 percent over the past decade, a boost closely correlated with the rising use of alternative assets, which has more than doubled since 2006. Additionally, state funds are paying billions of dollars in unreported performance fees associated with these alternative investments…..