FIGURE 1 : Dynamics of the Alternative Asset Class Cycle for Whaling , VC and Public Pension Plans
Note : The 10-year average excess return versus a passive index for public pensions for the 14 years ending in 2014 includes five data points for the 10-year periods ending in 2010 – 2014 .
Sources : Equable ( 2024 ); Aubry , Jean-Pierre and Yimeng Yin . 2024 . “ How Do Public Pension Plan Returns Compare to Simple Index Investing ?” Issue in Brief 24- 13 . Chestnut Hill , MA : Center for Retirement Research at Boston College ; Mark Higgins . “ A Whale of a Tale : The History of Venture Investing in the United States .” Financial History . Fall 2023 .
flood the asset class with capital . Within a few years , the supply of capital exceeds demand , which compresses future returns . But unlike the ebb and flow of publicly traded equity valuations , alternative asset classes become trapped in the late phase for many years . It may take several decades for allocators to appreciate that the supply and demand imbalance renders all but the most talented managers unable to produce returns that justify the corresponding fees , risk and illiquidity . Figure 1 shows the impact of the alternative asset class cycle on modern VC investors and 19th century whaling investors . It also shows how it has played out with 21st century public pension plan investors in multiple alternative asset classes .
A tell-tale sign that an alternative asset class cycle has entered the late phase is when fund managers shift their sales pitches from “ excess return ” to “ diversification .” This happened for buyout funds and hedge funds by the end of the 20th century , and it is now happening with the latest investment fad : private credit .
In the mid-1970s when investors began catching on to the dim prospects of active management , the founder of Eaton and Howard cynically advised his peers to embrace a new marketing pitch , declaring , “ Well , fellows , when it comes right down to it , mutual funds offer the public only two things : First diversification of investments and second professional management . When times are difficult , as they are now , we should stress diversification .”
If trustees listen closely to the consultants , advisors and staff surrounding them , they will hear a similar siren song . These voices often highlight the value of additional diversification without mentioning the imprecision of the asset class assumptions upon which such benefits depend . They tempt trustees with the promise of return enhancement without demonstrating that they possess the rare skills to capture it . Nevertheless , many trustees blindly accept the claim that investments in buyouts , VC , hedge funds and private credit are more likely to add value than destroy it .
In 2024 , nearly all alternative asset classes reside squarely in the late phase of their distinct life cycle . More than 80 % of public funds allocate to alternative asset classes , and the average allocation is roughly 34 % of their portfolios . Few trustees realize that this is not a sign of an attractive opportunity — it is a red flag
14 FINANCIAL HISTORY | Fall 2024 | www . MoAF . org