Going Against the Evidence: Public Funds Continue to Pile into Alternatives
In recent days I’ve been mulling over two stories that are depressing news for those of us who believe in public employee pension plans. About a week ago Dan Crum of the FT Alphaville wrote an excellent piece on the reasons why hedge funds and private equity cannot meet investor expectations. The piece, entitled “The hare gets rich while you don’t. Back the passive tortoise” borrows extensively from the work of Anthony Morris and Tam Rajendran. Morris and Rajendran are quantitative analysts at Nomura. While I haven’t been able to get my hands on their work, I highly recommend reading Mr. Morris’s article at: http://ftalphaville.ft.com/2014/08/01/1914342/the-hare-gets-rich-while-you-dont-back-the-passive-tortoise/. I’m not going to summarize the article as it touches on themes that have been the basis of this blog for nearly two years.
The second article, appearing in Pensions and Investments, reported “Cliffwater: State pension funds raising alternatives allocations.” Cliffwater is a consultant to institutional investors. Despite the evidence, most public pension plans are continuing to move their assets into alternatives. According to P&I’s story, the average allocation to alternatives increased to 25% from 24% in 2013. The average allocation to alternatives had been 21% in 2011. As recently as 2006, the average allocation to alternatives was only 10%.”
P&I also reported that, “among alternatives, private equity had the highest average allocation at 39% of the alternatives allocation, while real estate accounted for 35%, hedge funds at 17%, real assets at 7% and the rest in opportunistic.”
While CalPERS has started to pull back from alternatives, I’m not expecting the general trend to reverse. The alternative managers are too powerful. They have the uncanny ability to generate the charts and graphs needed to make their case. And the trustees and staffs at public plans are now complicit in this trend. They’ve made big commitments to alternatives, and it’s going to be hard for them to own up to their mistakes.
Let’s go back to the Nomura report. The prime brokers at Nomura who service hedge funds and the investment bankers who work with private equity firms can’t be too pleased with Mr. Morris and Mr. Rajendran. Their report is the equivalent of an equity analyst recommending that clients short the stock of a company. As a rule, the company won’t do business with an investment bank that issues that kind of report. While Morris and Rjendran have done great work, I’m not sure they have too many friends in their firm or on the Street.
Postscript: As I was finishing this post, I saw that McKinsey reported that alternatives investments have doubled since 2005. Globally, alternatives have grown by 10.7% per year, while traditional investments have grown at half that rate. Alternatives now command $7 trillion in assets. They don’t work, but they sure are popular. Of course, active money management doesn’t work, and folks have been betting on it for decades.