Key Takeaways
- • Public pensions raised the alternative-asset share of their risky portfolios from 14 percent in 2001 to 39 percent in 2021, while the overall target allocation to risky assets rose only modestly from 69 percent to 76 percent.
- • The variation across plans widened: by 2021 the gap between the 10th and 90th percentile pensions reached 39 percentage points (18 versus 57 percent), up from 26 points in 2001.
- • The Center for Retirement Research attributes the shift mainly to a growing belief that alternatives will outperform public equities on a risk-adjusted basis, shaped by investment consultants, peer behavior, and plan experience during the 1990s.
- • Consultant expected alpha for alternatives rose roughly 60 basis points since the early 2000s, with almost all of the increase from higher expected alternative returns rather than changes in risk or lower public equity returns.
- • Risk-appetite factors play a more limited role: a one-standard-deviation tighter risk constraint is associated with only a 3-percentage-point change in the alternative-to-risky share, explaining about 4 percent of cross-plan variation.
Summary
According to a Center for Retirement Research brief based on a forthcoming paper, U.S. public pension plans have meaningfully shifted the composition of their risky investments toward alternatives such as private equity, real estate, and hedge funds. At the turn of the century, alternatives accounted for 14 percent of public pensions' risky assets; by 2021 that share had grown to 39 percent. Using the Public Plans Database, the brief shows that the target allocation to alternatives rose from about 10 percent to 30 percent of total assets between 2001 and 2021, while public equity and fixed-income targets declined. The overall target share of risky assets, defined as public equities plus alternatives, rose only modestly, from 69 percent to 76 percent.
The adoption of alternatives has varied considerably across plans. The gap between the 10th and 90th percentile pensions reached 39 percentage points by 2021, up sharply from 26 points in 2001. The brief frames the question as whether changing investment beliefs, changing appetite for risk, or both explain this pattern.
On investment beliefs, the brief finds that consultants have grown more bullish on alternatives. Expected alpha, defined as the outperformance of alternatives over public equities after adjusting for risk, rose roughly 60 basis points since the early 2000s, with almost all of the increase attributed to higher expected alternative returns. Pensions whose consultants report higher alpha tend to hold higher alternative shares, and the authors argue this relationship reflects consultant influence rather than pensions selecting like-minded advisers. Widening consultant disagreement on alternative alpha accounts for roughly one-third of the growth in cross-plan dispersion since the early 2000s.
Peer effects are also significant. Using geographic peer networks, the brief finds that a 10-percentage-point increase in peers' alternative-to-risky share is associated with a 7.2-percentage-point increase in a pension's own share, and the result holds when lagged peer values are used. The brief also notes that U.S. endowments, U.S. corporate pensions, and U.K. corporate pensions have shown similar increases in alternative shares without comparable increases in risky shares, which the authors read as evidence of a broad shift in beliefs about alpha rather than a desire for more risk. Finally, late entrants to the 1990s equity boom, who experienced more of the dot-com bust than the rally, shifted more into alternatives after 2002; entry timing alone explains about one-fifth of cross-state variation in changes in the alternative-to-risky share between 2002 and 2021.
On risk-taking, the brief finds a weak relationship. Pensions that appear constrained from holding their desired risky share show only a modest tilt toward alternatives, explaining about 4 percent of cross-plan variation. The authors conclude that the primary driver of rising alternative allocations is the growing belief that alternatives will outperform public equities on a risk-adjusted basis, with appetite for risk playing a more limited role.
The adoption of alternatives has varied considerably across plans. The gap between the 10th and 90th percentile pensions reached 39 percentage points by 2021, up sharply from 26 points in 2001. The brief frames the question as whether changing investment beliefs, changing appetite for risk, or both explain this pattern.
On investment beliefs, the brief finds that consultants have grown more bullish on alternatives. Expected alpha, defined as the outperformance of alternatives over public equities after adjusting for risk, rose roughly 60 basis points since the early 2000s, with almost all of the increase attributed to higher expected alternative returns. Pensions whose consultants report higher alpha tend to hold higher alternative shares, and the authors argue this relationship reflects consultant influence rather than pensions selecting like-minded advisers. Widening consultant disagreement on alternative alpha accounts for roughly one-third of the growth in cross-plan dispersion since the early 2000s.
Peer effects are also significant. Using geographic peer networks, the brief finds that a 10-percentage-point increase in peers' alternative-to-risky share is associated with a 7.2-percentage-point increase in a pension's own share, and the result holds when lagged peer values are used. The brief also notes that U.S. endowments, U.S. corporate pensions, and U.K. corporate pensions have shown similar increases in alternative shares without comparable increases in risky shares, which the authors read as evidence of a broad shift in beliefs about alpha rather than a desire for more risk. Finally, late entrants to the 1990s equity boom, who experienced more of the dot-com bust than the rally, shifted more into alternatives after 2002; entry timing alone explains about one-fifth of cross-state variation in changes in the alternative-to-risky share between 2002 and 2021.
On risk-taking, the brief finds a weak relationship. Pensions that appear constrained from holding their desired risky share show only a modest tilt toward alternatives, explaining about 4 percent of cross-plan variation. The authors conclude that the primary driver of rising alternative allocations is the growing belief that alternatives will outperform public equities on a risk-adjusted basis, with appetite for risk playing a more limited role.
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