Are Alternative Investments Prudent?

Driven by funding and actuarial considerations, state and local public pension plans have been seeking additional investment options and are increasingly using alternative investments in their portfolios. Pension fund managers are potentially motivated to invest in alternative investments by several factors: including demographic shifts, general budget challenges, and two recessions. In trying to deal with these challenges, state legislators have changed laws and state pension systems have decided to shift their allocation strategies away from traditional equity and fixed-income investments to alternative investments. These alternative investments include hedge funds, private equity, and real estate. However, is this really a good strategy?

My thoughts go back to Warren Buffett’s 2008 $1 million bet with a hedge fund manager. The bet was simple: Buffett bet $1 million that over a 10-year period, the S&P 500 Index would beat a hand-picked portfolio consisting of five hedge funds. As we head into the final year of the bet, Buffett’s bet looks most assured. He explained that the costs of active investing, despite the intelligence of hedge fund managers, are greater than the benefits to the investor. In 2014, CalPERS, the largest public pension in the United States, stated that it is no longer investing in hedge funds, stating the decision was primarily driven by costs and complexity - at least somebody is listening. While hedge funds and other so called alternative investments have the allure of producing greater returns than the stock market, history has proven otherwise.

Click here to read my entire abstract article published by the CFA Digest. - Paul R. Rossi, CFA