Alternative Investments? State & Local Pension Portfolio Use and Performance

31 Pages Posted: 13 Mar 2014

See all articles by Paul Rose

Paul Rose

Ohio State University - Moritz College of Law; Bocconi University - BAFFI Center on International Markets, Money, and Regulation; Tufts University - The Fletcher School of Law and Diplomacy; Fundación Instituto de Empresa, S.L. - IE Business School

Jason S. Seligman

U.S. Department of the Treasury - Office of Economic Policy

Date Written: March 11, 2014

Abstract

Over the last decade, Defined Benefit (DB) public pension systems have come under greater stress. Pensions have experienced two recessions, demographic shifts and generally bad public budget circumstances. Pensions have modified their allocation strategies over this period, generally shifting away from equities and fixed income allocations in favor of alternatives. What’s more, the stated justification for alternatives has shifted as well, from an emphasis on relative performance (alpha) towards diversification away from systemic shocks (beta).

In this paper, we investigate motives for the employment of alternatives and the performance of these investments, considering both governance and financial performance motivations. We consider possible principal-agent and herding problems that may be unique to these portfolios, and find that the prudent person standard is of little protection against herding risks due to its relative benchmarking schema.

Controlling for changes in governance, we find that private equity and other less liquid alternatives can be of value because of their relatively consistent pricing, whereas more liquid assets are more susceptible to price volatility. In fact, improvements in diversification (beta) can arise as an artifact of illiquidity.

Keywords: public pension funds, defined benefit, asset allocaiton, alternatives, hedge funds, private equity, prudent person

JEL Classification: G23, K31

Suggested Citation

Rose, Paul and Seligman, Jason S., Alternative Investments? State & Local Pension Portfolio Use and Performance (March 11, 2014). Available at SSRN: https://ssrn.com/abstract=2407538 or http://dx.doi.org/10.2139/ssrn.2407538

Paul Rose

Ohio State University - Moritz College of Law ( email )

55 West 12th Avenue
Columbus, OH 43210
United States

Bocconi University - BAFFI Center on International Markets, Money, and Regulation ( email )

Milano, 20136
Italy

Tufts University - The Fletcher School of Law and Diplomacy ( email )

Medford, MA 02155
United States

Fundación Instituto de Empresa, S.L. - IE Business School ( email )

Calle Maria de Molina 12, Bajo
Madrid, Madrid 28006
Spain

Jason S. Seligman (Contact Author)

U.S. Department of the Treasury - Office of Economic Policy ( email )

1500 Pennsylvania Avenue
Washington, DC 20220
United States
(202) 622-1683 (Phone)

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