FIGURE 2 : Public Pension Fund Allocation to Alternative Asset Classes ( 2001 – 2022 ) and fail to properly consider the offsetting costs and probability of success . This behavior persists because trustees are surrounded by people who believe that their business models , careers and even their sense of self-worth depend on maintaining the status quo . The greatest irony is that all stakeholders can resurrect their value propositions by acknowledging the limits of their capabilities and discovering new value propositions to replace those that ceased adding value long ago . Perhaps the American Law Institute can serve as a catalyst of reform by issuing a fourth Restatement of Law Trusts and place greater emphasis on the obligation of trustees to properly consider plan fees before writing larger and larger checks using other people ’ s money .
Source : Public Pension Plans Data . Accessed June 28 , 2023 . https :// publicplansdata . org / public-plans-database /
Note : Alternative assets include assets categorized as private equity , hedge funds , miscellaneous alternatives , commodities and other . Although percentages varied , roughly 80 – 85 % of alternative allocations consisted of private equity and hedge funds in any given year .
Management . The book explained the strategy that he employed to produce exceptional returns for the Yale University endowment . Soon after its publication , institutional investors rushed to reengineer the “ Yale Model ,” but nearly all of them copied Yale ’ s strategy only at a superficial level , mistakenly concluding that the mere addition of alternative asset classes — such as venture capital , buyout funds and hedge funds — was all that was required . Few appreciated that the key to Yale ’ s success was a culture of excellence that was hardwired into the mind of every investment professional , trustee and asset manager who touched the portfolio . The Yale Model depended on the presence of a carefully crafted investment ecosystem that few institutions could hope to replicate . Nevertheless , soon after the publication of Pioneering Portfolio Management , trustees began chasing Yale ’ s returns by investing heavily in alternative asset classes . Figure 2 shows the total allocation of public pension plans to alternative asset classes from 2001 to 2022 .
Several decades have now passed since institutional investment plans began their steady migration toward alternative asset classes , and there is now a reasonably robust data set to evaluate whether the strategy has paid off . The results are not encouraging . In fact , in a recent study by Richard Ennis , one of the original founders of the institutional investment consulting profession , the use of alternative investments in a large sample of public pension plans resulted , on average , in a negative alpha of approximately 1.2 % per year .
A New Mandate for the Prudent Investor
The current interpretation of the Prudent Investor Rule appears to have outlived its utility once again . Adding alternative asset classes and using active managers in traditional asset classes is invariably accompanied by significant asset management fees , consulting fees , staff salaries , custodial fees and the hidden , but substantial , cost of neglecting other important financial priorities . Trustees often pursue diversification with little regard for the associated costs — and even less regard for their fiduciary obligation to ensure that the fees they pay on behalf of their beneficiaries are well spent .
The Prudent Investor Rule has now completed yet another long-wave transformation from solution to problem . Many , if not most , trustees place too much value on incremental increases in diversification
Mark Higgins , CFA , CFP ® is a financial historian , experienced institutional investment advisor and frequent contributor to Financial History magazine . His book , Investing in US Financial History , recounts the full financial history of the United States from 1790 to 2023 . The book will be published in February 2024 by Greenleaf Book Group .
Sources
Ennis , Richard . “ Have Alternative Investments Helped or Hurt ?” Social Sciences Research Network . September 21 , 2023 .
Fleming , Austin . “ Prudent Investments : The Varying Standards of Prudence .” Real Property , Probate and Trust Journal , 22 , no . 2 , pp . 243 – 255 . Summer 1977 .
Gold , Andrew S . and Robert W . Gordon . The American Law Institute : A Centennial History . New York : Oxford University Press . 2023 .
Higgins , Mark J . Investing in US Financial History : Understanding the Past to Forecast the Future . Austin , TX : Greenleaf Book Group . 2024 .
Pickering , Octavius . Cases Argued and Determined in the Supreme Judicial Court of Massachusetts , Volume IX . Boston : Hilliard , Gray , Little , and Watkins . 1831 .
Uniform Prudent Investor Act . National Conference of Commissioners on Uniform State Laws . February 14 , 1995 .
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