U.S. Pensions Less Enchanted with Alternatives

October 27, 2014 (PLANSPONSOR.com) - Confidence has returned among institutional investors worldwide, according to a survey by Pyramis Global Advisors.

The 2014 Pyramis Global Institutional Investor Survey found more than nine in 10 (91%) pension plans and other institutional investors believe they can achieve target returns in the next five years. Derek Young, vice chairman of Pyramis Global Advisors, in Boston, says in the U.S., 84% believe they can meet return assumptions.

However, Young tells PLANSPONSOR an interesting finding from the survey shows a return to basics for U.S. pension plan portfolios. “There’s a lot of discussion around asset allocation and whether practices had become too complex or had outgrown plan sponsor knowledge,” he says. “U.S. pension plan sponsors seemed more uncomfortable with their portfolios.”

Young notes that 59% of U.S. investors surveyed said they either somewhat understood the risk in their portfolios or didn’t understand it at all, meaning only 41% said they fully understand the risk in their portfolios. “If you don’t understand risk, you need to educate yourselves, but, the survey found, in the U.S., plan sponsors did not have the time to educate themselves on the complexity of strategies or asset classes,” he says.

The return-to-basics mentality especially showed up in U.S. plans’ views of alternative investments, and specifically in their views about hedge funds. According to Young, U.S. respondents ranked hedge funds as the investment approach most likely to underperform investor expectations over the long term, and only 19% said the benefits of alternative investment, such as hedge funds and private equity, are worth the fees being charged. Large plans are decreasing allocations to alternatives, and the reasons are complexity and not understanding risks.

Young notes Pyramis fielded the survey in the summer before the California Public Employees Retirement System (CalPERS) announced it is eliminating its hedge fund program. “The survey showed us what ended up happening at CalPERS,” he says. “Plan sponsors are getting away from the marketing story about what alternatives can do, looking at the reality of the history they now have with alternatives, and voting against them in a general sense.” Young points out that if you look at hedge funds in general, they have underperformed expectations and costs are much higher than for other investments; the risk-return profile is not what investors initially expected.

According to the survey, U.S. plans reported that the funded status of their plans is their top concern regarding their portfolios, with a majority saying they intend to improve it. Young says in the U.S. there is much more willingness to leverage outside help than in other countries. Thirty-eight percent of U.S. respondents said most of their new investment ideas come from outside consultants and asset managers; 36% said they come equally from internal and external sources.  

“I think it’s very important to use both internal and external sources,” Young says. “A lot of plan sponsors have significant expertise, and they shouldn’t lose sight of their own capabilities, but it is important to understand what you don’t know as well. Use outside help to complement your abilities. Use all possible resources to help you achieve risk and return goals.”

The survey includes 811 respondents in 22 countries representing more than $9 trillion (USD) in assets. There were 210 U.S. respondents representing $1.9 trillion in assets.

For additional information about the Pyramis survey, go to www.pyramis.com/survey.

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