Audit Says Alternatives Hurt Utah Retirement System

A report titled “A Performance Audit of URS’ Management and Investment Practices,” says the Utah Retirement System’s (URS) heavy allocation to alternative investments, including hedge funds, has diminished potential investment returns.

The report notes that URS’ alternative investments increased from 16% to 40% between 2005 and 2013 as URS reduced its allocation in equities and debt securities. URS states that the objectives of the current asset allocation are to protect investment capital in negative equity markets, reduce volatility, and increase investment diversification, according to the report.

Office of the Utah Legislative Auditor General hired consultant Chris Tobe to analyze URS’ investment performance. Tobe found that URS’ allocation of funds to alternatives is higher than that of peer systems. In its 2014 Report on State Pension Asset Allocation and Performance, Cliffwater LLC showed that, since 2006, most state pension systems have been moving assets into alternative categories. The report stated that, among 95 state pension systems, the average percentage allocation to alternative assets grew from 10% in 2006 to 25% in 2013.

In addition, Tobe’s model showed that if URS had maintained its 2004 allocation with fewer alternative assets and no hedge funds, it would have theoretically gained $1.35 billion in additional assets by 2013. Tobe recommends that URS reduce its allocation of 40% to alternatives over time, primarily by reducing the allocation to hedge funds.

However, the audit report notes that a memo dated March 2015, from Callan Associates, which serves as the primary investment consultant for URS’ portfolio states that Callan is still of the opinion that the current asset allocation “represents a reasonable and well thought out investment program intended to meet the assumed rate of return…”

In September 2014, the California Public Employees’ Retirement System (CalPERS), the largest public pension system in the United States, announced it would eliminate its hedge fund portfolio worth more than $4 billion. According to the audit report, that led other systems to evaluate their hedge fund investments, and many remained committed to them.