Texas, North Carolina, California, Pennsylvania and New Jersey have all jumped into alternatives in a big way, with public-sector pension plans now allocating nearly one-quarter of their assets to hedge funds, private equity, real estate and commodities.
Ramped-up state participation has paid off for them but other times it has come back to bite them — like in the case of Pennsylvania, which had 46 percent of its investments in riskier alternatives in 2012 but paid exorbitant fees, which brought its annual return to 3.6 percent, well below its target of 8 percent.
Of course, the popularity of hedge funds and other alternatives with institutional investors has had its negative effects. Some of the country’s largest hedge funds announced this year they would give money back to the institutions that were investing with them. The problem, they have found, is that they have so much capital invested now they don’t have enough of the right investments to buy into. They don’t feel they can get the returns they have in the past because they are growing too big.
Most hedge funds are exclusive, with 100 or fewer investors who pay a premium to be included in the investment.
The one thing all of these plans had in common was their above-average investment in alternatives. The average allocation to alternatives among the top-performing pension plans was equal to 29 percent at the end of June 2012.
The amount of money state pension plans invested in alternatives varied greatly from 0 percent to 65 percent, indicating that nobody knows the right amount of alternatives to invest in, Cliffwater found.