A Comparative Analysis of Pension Fund Investment Strategies

Public pension plans have increasingly invested their assets in alternative investments and increased reliance on external managers, yet recent studies suggest they could have achieved higher after-fee returns through simple index funds alone.

This brief reviews the evidence on this question. It compares public plan returns with those from simple index portfolios using data from several studies.

Alternative Assets

Over the past two decades, public pension plans have increasingly invested their assets in alternative investments like private equity funds, hedge funds, real estate and commodities – moving away from traditional stocks and bonds and towards alternative assets like private equity funds, hedge funds, real estate funds, commodities etc. They have also increased reliance on external managers1.1

These complex strategies tend to carry higher fees and less liquidity (making it harder to turn them into cash). Furthermore, their returns might not move in sync with traditional asset classes like stocks or bonds.

These investments may also be more difficult to value and have longer investment timelines, making it even more crucial that members understand how these investments are performing and any associated costs they’re paying.

Passive Management

Passive management involves investing in mutual and exchange-traded funds that track market indexes. Since these funds don’t require time or money spent picking individual stocks, they typically charge lower fees than active management funds.

Index funds and ETFs that track major market indices have made this strategy increasingly prevalent, automatically updating their holdings whenever a stock or index changes; when an additional stock becomes part of an index, for example, its holdings adjust automatically so as to match its performance – for instance when adding one stock may mean selling off another and buying another one simultaneously in order to match up performance with that index’s performance.

Passive investing may offer simplicity and transparency, but its potential returns don’t necessarily outstrip those offered by active management. Your goals and risk tolerance should play an integral role when selecting which approach is the most suitable one for you.

Active Management

Active management is a hands-on investment approach in which managers make investment decisions to outshout market or benchmark returns. This requires conducting extensive research and analysis before using their judgement to select investments they believe will outperform the market or benchmarks.

Passive management is an alternative to actively managed investing that involves creating portfolios to mirror the performance and risk characteristics of an index without trying to outstrip it. Passive strategies tend to be less expensive than active strategies.

Active management’s biggest advantages lie in its flexibility during volatile market environments like today’s. This flexibility enables managers to act swiftly and seize opportunities not present when markets are at their calmest.

Investors should understand that not all active funds are created equal. It takes skill and expertise to spot mispriced opportunities and exploit them effectively; additionally, as discussed in an earlier blog post there can be risks associated with active management that reduce its benefits.

Target Allocation

Studies conducted over time by academic researchers have confirmed that long-term asset allocation decisions such as security selection have far greater effects on overall returns and volatility than short-term tactical moves such as security selection. Therefore, BlackRock employs a systematic strategic asset allocation (SAA) process in their model portfolio construction and rebalancing processes.

Target-date funds designed to guide investors through retirement are designed to rebalance as they near their target dates, shifting away from investments focused on potential growth toward those that emphasize income generation. Once at target dates, many continue rebalancing until well into retirement when reaching their most conservative mix of investments.

This report offers several recommendations aimed at improving how these types of investments are implemented, specifically issuing guidance confirming that allocations that pass the Comparative PIP Test are respected as being in line with partners’ interests in their partnership provided they meet certain requirements.