Investing April 20, 2017

Public Pension Shift to Alternatives Results in More Volatility

Data from Pew does not reveal a best or one-size-fits-all approach to successful investing, but there is a uniform need for full disclosure on investment performance and fees.
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A shift to more complex investments has significantly increased fees, volatility, and potential losses, according to a report by The Pew Charitable Trusts examining investments by the 73 largest state public pension funds.

The analysis also estimates that $4 billion in investment fees are unreported each year.

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The report, “State Public Pension Funds Increase Use of Complex Investments,” finds the funds studied have assets under management of more than $2.8 trillion, making up about 95% of all state pension fund investments.

The use of alternative investments varies widely—from none to more than half of fund portfolios. While examples exist of top performers with long-standing alternative investment programs, the funds with recent and rapid entries into alternative markets—including significant allocations to hedge funds—reported the weakest 10-year returns. Although longer time horizons will allow better evaluation of these investment strategies, funds and policymakers should carefully examine risks, returns, and fees in the meantime, Pew says.

The data do not reveal a best or one-size-fits-all approach to successful investing, but there is a uniform need for full disclosure on investment performance and fees. In 2014, more than one-third of state-sponsored funds reported performance figures before deducting the costs of investment management. In addition, unreported investment fees—primarily performance payments made to private equity managers—totaled more than $4 billion in 2014, or about 40% above the $10 billion in reported investment expenses for that year.

“Public pension funds have increasingly relied on more complex investments in an effort to diversify portfolios and boost annual returns, a shift that can result in greater financial returns but also can increase volatility and the possibility of losses,” says Greg Mennis, director of Pew’s public-sector retirement systems project. “These trends underscore the need for transparency on plan performance and attention to the impact of investment fees on plan health.”

NEXT: Looking at returns

Looking at recent returns across state plans over the past five years, Pew found that funds posted overall fiscal year gains ranging from 17% in 2014 to 1% in 2016.

Government sponsors should consider investment performance both in terms of long-term returns and cost predictability, according to Pew. From this perspective, many fund portfolios are highly correlated with the up-and-down swings of the stock market and expose state budgets to considerable risk and uncertainty.

Investment performance varies widely among public pension funds, with only two of the funds examined exceeding investment return targets over the past 10 years. Although these results reflect the losses that occurred at the onset of the Great Recession, more recent performance, low interest rates, and forward-looking economic forecasts point to the need to closely examine long-term investment return targets.

The report is available for download here.
Investing April 20, 2017

Many Millennials Think Short-Term About Investing

There are some ways in which Millennials are demonstrating prudence and foresight as investors—and other ways they are not.
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A new survey report from AMG Funds identifies a number of ways Millennials in general make good candidates for advice. They are eager to start investing and just coming into their prime earning years, yet they are also fairly uninformed about the best strategies for planning the long-term financial future.

Case in point, Millennials with money already in the markets often display overly conservative allocations—but they speak of higher return expectations at the same time, compared with older counterparts.

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“Millennial investors appear to be more conservative than older generations of investors in their asset allocation, allocating 30% on average toward equities, lower by nearly one-third than older generations, who allocate 46% to the asset class,” AMG Funds reports. “On the other hand, Millennials allocate nearly three times as much of their portfolios toward alternatives (17%) than older investors do (6%).”

Important to note, the Millennials surveyed here already have significant assets saved—$250,000 at a minimum. Far outstripping the projections of sober-minded asset managers, this group expects to earn an average annual return of 13.7% in the years ahead. Boomers, who as a group anticipate 7.7% annual returns for the foreseeable future, are a little closer to matching the expectations of the vast majority of money management professionals, which stand in the mid- to low-single digits.

“Millennials also maintain a higher average cash allocation than their Boomer counterparts (25% vs. 17%),” AMG Funds observes. “In order to meet the Millennial investor’s average annual return expectation and also overcome the drag generated by the higher cash allocation in the average Millennial’s portfolio, the remaining asset classes would need to generate an average annualized return of 18.3%, considerably higher than the 9.8% average annualized return of the S&P 500 Index over the past 15 years.”

NEXT: Education and advice sorely needed

In juxtaposition to Millennials’ unrealistic return expectations, the generation is more than twice as likely to consider themselves “extremely” or “very” knowledgeable about investing. Yet nearly two-thirds of Millennials define “long-term investing” as applying to a period of less than five years—a definition most investing professionals would disagree with.  

There are some ways in which Millennials are demonstrating prudence and foresight, AMG Funds finds. For example, Millennials are “much more likely than older investors to be concerned about having enough money for their retirement years (69% vs. 28%).”

The survey report goes on to show many Millennials prefer computer-generated portfolios and automated asset-management products. “Specifically, Millennials are at least twice as likely as the broader group of respondents to believe that advisers recommend generic portfolios as opposed to providing customized advice, and that computer-generated portfolios are less risky and generate higher returns than those managed by humans,” AMG Funds says. “Nimble and adaptable advisers may be successful in connecting with Millennial investors through education and advice that focuses on helping them to meet their long-term goals.”

The analysis concludes that Millennials “seek out professional financial advice for different reasons than older investors.” Forty percent in the younger age group cited a desire to work with advisers “to enter new investment categories,” while a desire to improve results relative to their own investing ability was the prime driver for Gen X investors. Boomer investors cited a major life change or upcoming event as the most common trigger.

“When asked about the benefits of using a robo-adviser, respondents among the full range of investor age cohorts pointed toward cost (67%), unbiased advice (58%), and the flexibility to engage at a time of their choosing (57%),” AMG Funds says. “The survey results found stronger responses to negative associations regarding robo-advisers relative to responses regarding the perceived benefits; 81% of respondents felt that robo-advisers use a cookie-cutter approach; 80% believe that computer-generated portfolios do not account for qualitative information; and 78% criticized robo-advisers for not offering a dedicated point of contact.”

For more information on the results of AMG Funds research, visit www.amgfunds.com/wealth-trends. 

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