Public pension plans evaluate their performance by comparing returns by asset class to certain benchmarks—and in the quest to beat benchmarks, they seek out external asset managers to do just that.

However, according to a brief from the Center for Retirement Research at Boston College, with fees under scrutiny for what they may or may not help a plan to do, researchers have found that plans paying higher fees aren't doing themselves any favors in beating benchmarks.

In fact, plans that pay higher fees actually get worse performance relative to those benchmarks.

Asset classes didn't change whether a plan beat a benchmark or lost ground against it. But alternative asset classes, such as private equity and hedge funds, performed particularly badly under higher fees.

The report points out that plans compare their returns by asset class to specifically chosen benchmarks that reflect their investment goals for the asset class. And that's what they pay external asset managers for: to beat those benchmarks.

Researchers considered the asset classes of domestic equity, international equity, fixed income and alternatives, that last broadly consisting of real estate, commodities, private equity and hedge funds.

Established indices are generally used as benchmarks, but for alternative asset classes there's more variation in the benchmark choices, so to benchmark a whole portfolio, the report says, “state and local plans use either a weighted average of asset class benchmarks, the average performance of a selected peer universe, the expected rate of return on investments, or a public index (often, plus a premium).”

And while the report found that the annualized return from 2002–2016 in plans outperformed their blended benchmark by 31 basis points on average, individual plan experience wasn't anywhere near that consistent.

About a third of plans underperformed their benchmark, a third outperformed within 50 basis points, and another third outperformed by 50 basis points or more.

It highlighted the fact that the range in performance stems from both differences in net returns and differences in benchmark choices for each asset class.

And then there's the question of how they perform relative to benchmarks and fees.

Data from 2011–2016 indicate that higher fees correlate to lower net-of-fee performance relative to benchmarks, and that plans that underperform their benchmarks pay higher fees across all major asset classes—particularly for alternative assets such as private equity and hedge funds.

In addition, research indicates that “it is clear that alternatives charge much higher fees than traditional asset classes such as public equities and fixed income” and that “plans that underperformed their blended benchmark from 2011–2016 reported higher expense ratios than plans that outperformed their benchmark, particularly within alternative asset classes.”

The report concludes that “investment fees—in particular, outsized fees on alternatives—may play a meaningful role in plan underperformance.”

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