Alternative Investments Boost State Pension System Returns

August 7, 2014 ( – State pension systems earned a median 7.2% annualized return over the 10 years ended June 30, 2013, with individual pension fund returns ranging from 5.0% to 8.8%, according to Cliffwater LLC.

The “Cliffwater 2014 Report on State Pension Asset Allocation and Performance” finds that efforts by state pension systems to do better than a simple mix of stocks and bonds through alternative investments has been largely rewarded. Real estate and private equity allocations, where there is a large sample of 10-year returns, performed well.

However, the report also reveals that there were significant return differences among states over the last 10 years. Some of these differences are the results of the level of risk reflected in asset allocation. Return differences can also be the result of implementation, and specifically the selection of strategies and managers within asset classes, particularly alternatives. The report’s authors note that those overseeing state pension systems must continue to allocate resources to staff and advisers to maximize the return potential from its asset classes.

Many public pensions are shifting their asset allocation toward what is referred to as the “endowment model,” according to the report. Endowments have historically had higher allocations to alternatives. However, while state pension systems added another 1% to alternatives in 2013, mostly from fixed income, bringing their total dollar weighted alternative allocation to 25% of assets, this is still less than one-half the 53% allocation to alternatives for endowments. Alternatives allocations ranged from 0% for five of the 95 state pension systems reporting to a high of 61%.

The composition of alternatives within state pensions also differs from endowments; hedge funds represent 36% of the endowment allocation to alternatives compared to 17% for state pensions. Cliffwater notes the source of funds for alternatives has changed from stocks to bonds, which dropped three percentage points in the most recent year. The firm predicts that future funding for alternatives will continue to come from fixed income given their current low yields and the increasing trustee comfort with lower risk hedge funds as an alternative to fixed income.

Cliffwater’s report may be downloaded from Cliffwater LLC is a provider of alternative advisory services to institutional investors including endowments, foundations, retirement systems and financial institutions.