The Grand Experiment: The State and Municipal Pension Fund Diversification into Alternative Assets

Abstract

Over a nine-year period (2008–2016), state and municipal pension funds embarked on a grand experiment. They boosted their commitments to alternative assets, spending tens of billions of dollars per year on additional third-party money management fees. The funds’ diversification strategy covered a variety of tactics involving mostly private, but some public, assets. The ostensible purpose of this expenditure was to realize both (i) greater returns and (ii) lower volatilities than those that were produced by the low-cost indexing of publicly-traded investments, which mimicked the funds’ actively-managed asset allocations. This paper compares aggregate public pension fund returns and volatilities, over differing time periods, with a series of institutional benchmarks and replicating indexes. We conclude that the states and municipalities obtained neither lower risk nor higher returns with the higher level of active management and diversification implied by alternative assets. The experiment is thus a failure.