Pension Plan Investments in Alternative Assets Pose Serious Risk to Taxpayers and Members

Reason Foundation, in an opinion piece on public pension investment, contends that public pension systems have turned to alternative investments since the 1990s as returns from traditional bonds and large-cap equities diminished. Limited partnership vehicles such as private equity, privately held debt, and hedge funds are attractive to underfunded plans because of their return potential, but the article argues that their lack of transparency and exposure to losses at liquidation make them especially risky for taxpayers and retirees.

The article describes the funding pressure behind this shift. Pension plans rely on member contributions, employer contributions funded by taxpayers, and investment returns. As of August 2020, the weighted average assumed rate of return among state-managed public pension systems was 7.25 percent, while the average 20-year return was 6.3 percent. The pivot toward alternatives intensified after the 2008 financial crisis, according to the article.

The central concern is valuation. Private equity general partners buy and liquidate businesses over 10 to 12 years, and until then actuaries rely on values reported by the limited partner. Returns depend heavily on market conditions at the time of resale, and the article warns that holding assets for better conditions can delay realized returns for an unknown period. Reason Foundation says these assets are the most difficult to value because they depend on assumptions about future cash flows and exit multiples, exposing plans to potentially catastrophic losses borne ultimately by taxpayers and members.

To address these risks, the article recommends fuller reporting. It proposes a limited partner portfolio performance report disclosing, for each holding, the investment vehicle name, investment date, capital committed, capital contributed, capital distributed, and internal rate of return. CalSTRS is cited as already providing such transparency, and Ohio and New Mexico are considering bipartisan legislation requiring similar reporting, with support from budget watchdogs and labor unions.

The article also highlights the Excess Value Method, developed by Landmark Partners and the Public Employees Retirement Association of New Mexico, which measures in dollar terms how private limited partnership managers perform relative to a comparable public benchmark. The piece argues that the current carried interest formula compensates managers on absolute returns without accounting for risk, and that public pension benefits are paid from net rather than gross returns, so fees and expenses should be transparent and consistently monitored.