Fitch casts doubt over returns from alternative investments

Ratings firm has analyzed returns for public pension funds over 17 years

Fitch casts doubt over returns from alternative investments
Steve Randall

The rise of alternative investments among public pension funds has been notable in the past 17 years but a report suggests the strategy may not be as strong as hoped.

Fitch Ratings has analyzed the performance of investments made by public pension funds in the US between 2001 and 2017 and found that overall returns for alternative investments do not always outperform fixed income and equity investments.

Asset allocation to equities and alternative investments increased to 77% in 2017 from 67% in 2001, while asset allocation to fixed-income investments and cash declined to 23% in 2017 from 33% in 2001.

But this increase in alternative investments was not necessarily reflected in an increase in investment returns over the same period, the report says.

The analysis shows that a passive 70% equity/30% fixed-income allocation produced a slightly better average investment return of 7.0% compared to a 6.7% average return for a 60% equity/40% fixed-income allocation, but with more volatility as reflected by the higher standard deviation.

Most plans show average returns between 6% and 7%, and both the 70/30 and 60/40 allocations show returns at the higher end of this range.

The average returns over this period underscore higher long range investment return assumptions are unrealistic, particularly in the context of more volatile asset performance and the historically low inflation and interest rates of recent years.

Fitch looked at median average returns for those plans with asset returns broken out by allocation and reported annually at least 80% of the time.

Looking at median investment returns broken out by allocation, most alternative investments did not perform any better than equities. For the 10-year timeframe, only private equity performed better than equities.

Fitch uses data provided by Boston College's Center for Retirement Research (CRR). The CRR database includes 180 state and local plans, accounting for around 95% of the total state and local pensions by assets and plan participants. When looking at investment returns across plans, data was not available for each investment allocation every year.