Beliefs, Not Empirical Evidence, Have Driven the Boom in Alternatives, According to New Academic Research

A new academic paper, "The Rise of Alternatives," by Stanford Graduate School of Business associate professor Juliane Begenau, PhD candidate Pauline Liang, and Harvard Business School's Emil Siriwardane, argues that the large pension allocation to alternative assets over the past two decades was driven largely by investment consultants' beliefs that these assets would outperform public equities. According to the authors, consultants convinced pensions and their peers that "alternatives would add alpha relative to public equities," despite limited evidence that this occurred.

The study covers 2001 to 2021. Over that period, the share of alternatives in the national public pension portfolio rose to 30% from 9%, with pensions reallocating away from public equities into private equity, real estate, and hedge funds. The authors found that consultant-reported expectations of alternatives' alpha relative to public equities rose steadily from the 2000s. The largest increase was in private equity, with expected alpha up 88 basis points from 2003 to 2021, a year the authors note marked the top of the private equity market. Meanwhile, alternatives did not outperform an investable global market portfolio benchmarked to State Street's GMP. By 2010, pensions' alternatives were lagging the benchmark, and by 2021 pensions were roughly 17 percentage points overweight alternatives in their risky portfolios relative to the global market portfolio.

The researchers quantified the drivers of the shift. Consultants' own bullishness accounted for about 12% of the increase, while about 20% of the change in views came from peer firms amplifying consultants' positions. Dan Rasmussen, founder of Verdad Advisers, described the dynamic as self-reinforcing correlated belief, citing Stanford economist Mordecai Kurz's work on markets where agents hold correlated beliefs. Rasmussen said the paper is "essentially an empirical demonstration of Kurz's theory in action," and argued that capital market assumptions "are not just inputs; they are persuasive tools."

The authors do not declare alternatives a poor investment, but they caution that "more work is needed to assess whether beliefs about alpha are rational," with implications for pension beneficiaries given the costs and complexity of the asset class. They also suggest pensions' experience with stock market crashes in 2000 and 2008 after being permitted to invest in equities in the 1990s may have contributed. Finally, the paper finds that for every dollar moved out of fixed income since 2001, $2.72 went into alternatives and $1.72 came out of public equities.