A recent article in the New York Times points out that pension funds that have stuck to more traditional investments have outperformed pensions that have a higher concentration of alternative investments like private equity, hedge funds and real estate. This begs the question are alternative investments worth it? Based simply on the article its hard to judge given that the time period reviewed is such a short time horizon. The pensions have much longer time horizons and over longer periods of time it is possible that these alternative investments could add value. However, due to their high fee structures they must reach a significantly higher performance hurdle in order to deliver value.
The significant issue to be gleaned from the data presented in the article is that the alternative heavy portfolios underperformed despite a large financial shock that occurred over the 5 year time horizon examined. Proponents of adding alternative investments to a portfolio argue that the investments provide diversification and downside protection from major financial shocks. Many hedge funds seek absolute returns, meaning positive returns in all market environments and private equity investments are expected to provide performance uncorrelated with the stock market. However, when these investments were needed most, in the throes of the Great Recession, they did not aid pensions’ portfolios. If these investments are not providing the benefits their proponents claim then it should make investors think twice about an allocation.