Key Takeaways
- • Public pension plans posted an average negative return of 5.5 percent in FY 2022 as of June 30 for about 110 plans that report on a June fiscal year, while the 1-year return across all 170 plans examined was negative 7.1 percent.
- • Public plans averaged an annualized return of only 5.9 percent from 2001 to 2022, well short of the roughly 7 to 8 percent actuarial assumed returns, according to the Center for Retirement Research (CRR).
- • Alternatives (private equity, hedge funds, real estate, and commodities) rose from 9 percent of state and local plan portfolios in 2001 to 34 percent in 2022.
- • The CRR concludes that from 2001 to 2022 alternatives have not improved overall pension returns, although they may have dampened reported volatility.
- • Reported alternative returns are subject to appraisal lags, survivorship bias, and backfill bias, so headline performance figures likely overstate actual earned returns.
Summary
Fiscal year 2022 was a difficult period for state and local pension plans, as the decline in equity markets erased much of the gains recorded in 2021. Media reports, including coverage by Pensions and Investments and the Wall Street Journal, had suggested that alternative investments explained why reported pension returns did not look worse. The Center for Retirement Research (CRR) argues that short-term results are an inadequate measure for long-term investors and frames the central question as whether alternatives have helped or hurt pension performance over time.
According to the CRR's analysis of the Public Plans Database (PPD), which covers roughly 220 major plans representing over 95 percent of U.S. state and local pension assets, public pensions averaged a negative 5.5 percent return in FY 2022. Calculated on an annualized (geometric) basis, plans averaged only 5.9 percent from 2001 to 2022. Net-of-fee annualized returns were 7.8 percent over 10 years and 5.8 percent over 15 years per the PPD, while U.S. Census Bureau data showed 8.6 percent over 30 years. Plans have reduced their assumed return from about 8 percent in 2001 to about 7 percent in 2022, but cumulative realized returns have still fallen well short of these expectations. Top-quartile plans earned 6.8 percent on average, compared with 5.1 percent for bottom-quartile plans.
The allocation to alternatives, defined as all holdings other than traditional stocks, bonds, and cash, rose from 9 percent in 2001 to 34 percent in 2022. By 2022 the largest allocation held by any plan exceeded 50 percent, while in 2001 almost three-fifths of plans held less than 10 percent in alternatives. The composition has also shifted, with real estate's share of alternatives falling sharply while hedge fund and commodity allocations grew.
The CRR cautions that measuring alternatives' impact is complicated by appraisal-based valuations and quarter-lagged reporting for private assets, which can make annual results imprecise. Index benchmarks for private equity and hedge funds are also subject to survivorship and backfill bias. The CRR cites Ibbotson, Chen, and Zhu (2011), which found that correcting for these biases reduced the average hedge fund return from 14.9 percent to 7.7 percent over 1995 to 2009. Even so, alternatives delivered robust returns from 2001 to 2007, substantially outpacing traditional equities, and lost less than equities during the financial crisis, with real estate the exception. Since the crisis, performance has been more mixed, with private equity and real estate recovering somewhat while hedge funds and commodities have lagged.
The brief tests the relationship between alternative allocations and portfolio returns using regressions over 2001 to 2009, 2010 to 2022, and 2001 to 2022, controlling for fixed income and cash. The CRR's conclusion is that pension performance since 2001 has fallen short of actuarial expectations and that the growing reliance on alternatives has not helped overall returns, although it may have dampened reported volatility.
According to the CRR's analysis of the Public Plans Database (PPD), which covers roughly 220 major plans representing over 95 percent of U.S. state and local pension assets, public pensions averaged a negative 5.5 percent return in FY 2022. Calculated on an annualized (geometric) basis, plans averaged only 5.9 percent from 2001 to 2022. Net-of-fee annualized returns were 7.8 percent over 10 years and 5.8 percent over 15 years per the PPD, while U.S. Census Bureau data showed 8.6 percent over 30 years. Plans have reduced their assumed return from about 8 percent in 2001 to about 7 percent in 2022, but cumulative realized returns have still fallen well short of these expectations. Top-quartile plans earned 6.8 percent on average, compared with 5.1 percent for bottom-quartile plans.
The allocation to alternatives, defined as all holdings other than traditional stocks, bonds, and cash, rose from 9 percent in 2001 to 34 percent in 2022. By 2022 the largest allocation held by any plan exceeded 50 percent, while in 2001 almost three-fifths of plans held less than 10 percent in alternatives. The composition has also shifted, with real estate's share of alternatives falling sharply while hedge fund and commodity allocations grew.
The CRR cautions that measuring alternatives' impact is complicated by appraisal-based valuations and quarter-lagged reporting for private assets, which can make annual results imprecise. Index benchmarks for private equity and hedge funds are also subject to survivorship and backfill bias. The CRR cites Ibbotson, Chen, and Zhu (2011), which found that correcting for these biases reduced the average hedge fund return from 14.9 percent to 7.7 percent over 1995 to 2009. Even so, alternatives delivered robust returns from 2001 to 2007, substantially outpacing traditional equities, and lost less than equities during the financial crisis, with real estate the exception. Since the crisis, performance has been more mixed, with private equity and real estate recovering somewhat while hedge funds and commodities have lagged.
The brief tests the relationship between alternative allocations and portfolio returns using regressions over 2001 to 2009, 2010 to 2022, and 2001 to 2022, controlling for fixed income and cash. The CRR's conclusion is that pension performance since 2001 has fallen short of actuarial expectations and that the growing reliance on alternatives has not helped overall returns, although it may have dampened reported volatility.
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