Analysis of public-pension funds indicates that risk and fees matter. Some pension funds for state and local employees have sought higher risk investments in order to boost returns and make up for funding shortfalls. In an attempt to make up for shortfalls, they began putting some of their investments into hedge funds, direct real-estate investments, and private equity arrangements.
Other pension funds have stuck to a traditional diversified stock and bond mix.
The New York Times reported that the Pennsylvania State Employees’ Retirement System has put almost half of its assets into private equity, real estate and other riskier alternative investments. The pension fund had only a 3.6% annualized return over the past five years, and it paid $1.35 billion in management fees.
Meanwhile, the Georgia Municipal Retirement System is prohibited by law from using such investments. It invested in a standard diversified mix of stocks and bonds and earned a 5.3% annualized return over the same period, while paying only $54 million in management fees.
Investment research firm Preqin recently said that Pennsylvania was among a group of pension systems taking the highest risks, while Georgia’s system was in the group taking the lowest risks. Preqin’s study found that those pension funds that had more than one-third of their money in riskier alternative investments earned an average of one percentage point less than pension funds that avoided such investments. Meanwhile, the riskier pension funds paid an average of four times more in fees.
The results suggest that the returns on some alternative investments do not justify their higher fees. Avoid expensive, non-transparent investments with hard-to-understand “secret sauce” investment strategies. If you don’t understand it, stay away from it. Rather, invest in transparent investments that make sense to you.
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