By James Kwak
From a Times article on pension fund investing:
Mr. Dear cautioned that there were big differences in how various alternative investments performed during the financial crisis.
He said that Calpers’s investments in real estate had been “a disaster” and that its hedge fund investments had not met their benchmarks and were under review. But he said that its private equity holdings had easily beaten public stock returns over the last decade.
“Over the longer term, that kind of outperformance represents real skill, not luck, and it’s worth paying for,” he said.
Holy confirmation bias, Batman! When one asset class beats the stock market that’s skill. But when your other asset classes do badly—that’s random variation? If high returns on private equity are evidence that you should continue investing in private equity, then low returns in hedge funds and real estate are evidence that you should pull your money out of them.
Public pension funds are obviously gambling on redemption. They don’t have enough money to meet their long-term commitments. They can only meet those commitments by getting unrealistic returns, so they are piling into alternative asset classes in hopes of getting those returns.
This is the same as S&Ls piling into wacky commercial real estate ventures in the 1980s. If you’re a pension fund manager, there’s only upside. Either the bets pay off and you become a hero (and move into the private sector), or they fail and the losses get shifted to taxpayers and public employees. And either way, the hedge fund and private equity fund managers get their guaranteed fees (along with the pension consultants who supposedly know which funds you should invest in).