Risky Bets Weigh on U.S. Pension Returns ; Alternative Investments by Public Workers' Funds Trailed Stocks and Bonds

Article excerpt

Funds that sought higher returns to bridge shortfalls by turning to private equity, hedge funds and real estate have seen lower returns in the past five years than have funds that stayed with stocks and bonds.

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Searching for higher returns to bridge looming shortfalls, public workers' pension funds across the United States are increasingly turning to riskier investments in private equity, real estate and hedge funds.

But while their fees have soared, their returns have not. In fact, a number of retirement systems that have stuck with more traditional investments in stocks and bonds have performed better in recent years, for a fraction of the fees.

Consider the contrast between the state retirement fund for Pennsylvania and one in Georgia.

The $26.3 billion Pennsylvania State Employees' Retirement System has more than 46 percent of its assets in riskier alternatives, including nearly 400 private equity, venture capital and real estate funds.

The system paid about $1.35 billion in management fees in the past five years and reported a five-year annualized return of 3.6 percent. That is below the target of 8 percent needed to meet its financing requirements, and it also lags behind a 4.9 percent median return among public pension systems.

In Georgia, the $14.4 billion municipal retirement system, which is prohibited by state law from putting its money in alternative investments, has earned 5.3 percent annually over the same time and paid a total of about $54 million in fees.

The two funds represent the extremes, with Pennsylvania in a group of pension systems with some of the highest percentages of investments in alternatives and Georgia in a group of 10 with some of the lowest, according to groupings of funds identified by the London-based research firm Preqin.

An analysis of the sampling presents an unflattering portrait of the alternative bets: The funds with a third to more than half of their money in private equity, hedge funds and real estate had returns that were more than a percentage point lower than returns of the funds that largely avoided the riskier assets. They also paid nearly four times as much in fees.

While managers for the retirement systems say that a five-year period is not long enough to judge their success, those fees nevertheless add up to hundreds of millions of dollars each year for some of the country's largest pension funds. The $51.4 billion Pennsylvania public schools pension system, for instance, which has 46 percent of its assets in alternatives, pays more than $500 million a year in fees. It has earned 3.9 percent annually since 2007.

Whether the higher fees charged by the alterative-investment firms are worth it has been hotly debated within the investment community for years. Do these investment entities, over an extended period of time, either offset the wild swings in assets during rough patches of the market or provide significantly higher gains than could be found in less-expensive bond and stock investments?

"We can't put it in Treasury notes and bonds; that's just not making any money," said Sam Jordan, the chief executive of the Austin Police Retirement System in Texas.

James Wilbanks, executive director of the Oklahoma Teachers Retirement System, which has largely stayed with stocks and bonds, said that pension funds were obligated to take a cautious approach. "We all heard the stories about institutional funds that had more than half of their assets in private equity in 2008" and then had to sell, he said.

While both sides of the debate can point to various studies, the topic is taking on a sharper focus as more funds embrace the riskier strategy. By September 2011, retirement systems with more than $1 billion in assets had increased their stakes in real estate, private equity and hedge funds to 19 percent, from 10.7 percent in 2007, according to the Wilshire Trust Universe Comparison Service, known as Wilshire TUCS. …

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