Corporate Pension Plan Investments in Alternative Assets: Determinants and Consequences
This study examines the determinants and consequences of corporate defined-benefit
pension plan investments in ‘alternative assets’. While there is no universally accepted definition
of the term ‘alternative asset’, this term is commonly used to refer to hedge funds, private equity,
securitized assets (such as collateralized mortgage obligations) and real assets such as
commodities, timber, oil and gas (Edwards and Gaon 2003).
The Goldman Sachs / Frank Russell Survey of Alternative Investments (1995) defines these investments as private, illiquid investments other than the traditional investments of stock, fixed-income securities, real estate and cash or cash equivalents. Recent surveys report that corporate pension plans are increasingly moving assets away from common stocks and bonds into hedge funds and private equity funds. One such study reported that “retirement plans will be the largest cumulative investors in hedge funds in the period 2006 to 2010, accounting for 65% of the total inflows into hedge funds” (Bank of New York 2006). The Pensions & Investments survey of the 200 largest defined benefit sponsors in the U.S. reported that hedge funds, venture capital and private equity were amongst the top growing asset classes since 2000 (Pensions & Investments 2008).
Alternative investments by public and corporate pension funds have been the focus of much regulatory attention in recent times. The SEC stated in a staff report, “Our immediate concerns stems from the increasing presence of these (institutional) investors in hedge funds over which neither the Commission nor any other regulatory authority exercises meaningful oversight” (SEC 2003). Members of the U.S. House of Representatives suggested in a hearing of the House Financial Services Committee in March 2007, that pension fund investments in hedge funds may deserve Congressional scrutiny ‘to protect ordinary investors from the risks that these investments represent’. The Financial Accounting Standards Board has also announced a proposal to improve disclosures of pension investments in alternative assets. To quote FASB Chairman Robert Herz, “A lot of institutional investors, including pension funds, have been going to alternative investments – hedge funds, private equity, structured notes. Users might want to know that they’re invested in volatile instruments.”