The study by CEM Benchmarking Inc., an independent provider of cost and performance analysis for pension funds and other institutional investors, and the National Association of Real Estate Investment Trusts (NAREIT), which represents REIT providers and publicly traded real estate companies with an interest in U.S. markets, suggests concern about volatility and the adequacy of pension funding has focused a great deal of attention on investment performance and fees, leading to enthusiasm about new asset classes and styles of investing.
Alexander Beath, a CEM analyst and author of the study, says the data underscore that investment costs and allocation decisions matter hugely when it comes to long-term net returns. The study looks at the performance of trillions of dollars in pension investments between 1998 and 2011, a time during which fundamental changes occurred in the defined benefit (DB) market.
During this period, Beath explains, many pension funds increased their investments in alternative assets, including private equity, hedge funds, real estate and other real assets such as commodities and infrastructure. In fact, the pension funds analyzed by CEM showed nearly a 400% increase on average for alternatives allocations.
CEM says this reallocation to alternatives paid off in terms of gross returns and realized returns net of fees charged by investment managers.
“Many pension plans could have improved performance by choosing different allocation strategies and optimizing their management fees,” Beath adds. “Listed equity REITs delivered higher net total returns than any other alternative asset class for the 14-year period we analyzed, driven by high and stable dividend payouts, long-term capital appreciation and a significantly lower fee structure compared with private equity and private real estate funds.”
Further highlighting the importance of fee considerations, Beath observes that the private equity asset class actually had a higher gross return on average than listed REITs did during the time period analyzed (13.31% vs. 11.82%). But, critically, private equity charged fees nearly five times higher on average than REITs, at 238.3 basis points (bps) for private equity vs. 51.6 bps for REITs. As a result, listed equity REITs realized a better net return. REITs also outperformed the 6.06% average return on large-cap stocks and 8.97% return on U.S. long-duration bonds.
Other alternatives also showed some impressive performance between 1998 and 2011, Beath says. Commodities and infrastructure returned 9.85% on average, and net returns for private real estate were 7.61%. Hedge funds returned 4.77%.
CEM used the information on realized net returns to estimate the marginal benefit that would have resulted from a theoretical pension fund’s 1-percentage-point increase in allocation to the various asset classes. Increasing the allocations to long-duration fixed income, listed equity REITs and other real assets would have had the largest positive impact on plan performance, Beath says. For example, for a typical plan with $15 billion in assets under management (AUM), each percentage point increase in allocations to listed equity REITs would have boosted total net returns by $180 million over the time period studied.
A big upshot of the study is that allocations changed considerably on average from 1998 through 2011, CEM notes. Of the defined benefit plans analyzed, public pension plans reduced allocations to stocks by 8.5% and to bonds by 6.6% while increasing the allocation to alternative assets, including real estate, by 15.1%. Corporate plans reduced stock allocations by 19.1% while increasing allocations to fixed income by 10.5% (consistent with a shift to liability-driven investment [LDI] strategies), and to alternative assets by 8.6%.
For the DB market as a whole, allocations to stocks decreased 15.1%; fixed-income allocations increased by 4.3%; and allocations to alternatives increased by 10.8%, CEM says. In dollar terms, total investment in alternatives for the 300-plus funds in the study increased from approximately $125 billion to nearly $600 billion over the study period.
A full copy of the CEM/NAREIT benchmarking study, “Asset Allocation and Fund Performance of Defined Benefit Pension Funds in the United States Between 1998-2011,” is available for download here.
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