The Rise of Alternatives

Abstract

Since the 2000s, U.S. public pensions have rotated heavily out of public equities and into alternative assets like private equity and hedge funds. This behavior is typically attributed to reaching-for-yield incentives created by the secular decline in safe interest rates, like those related to pension underfunding or binding portfolio constraints. We argue that such mechanisms are unlikely to explain the rise of alternatives without a concurrent shift in beliefs. Several facts support the idea that the perceived risk-adjusted return of alternatives has increased over time. Pension beliefs appear to be shaped by consultants, peers, and experience in the 1990s.

Keywords: Public Pensions, Private Equity, Alternatives, Beliefs, Reaching for Yield, Underfunding

JEL Classification: G11, G23, G29, G41, H55, H75