Are Institutional Investors Too Reliant on Alternatives?

The conventional wisdom concerning institutional investors has been that since positive returns are so difficult to achieve in the current environment, hedge funds have become the most logical place for them to park their money.

Earlier this month, Advanced Trading pointed out that part of the allure of a hedge fund investment to a pension fund or an endowment is its ability to generate non-correlated returns in a time where assets like fixed income, commodities and currencies have grown more correlated to an increasingly wild equities market.

Pension funds find this to be particularly valuable since they all work along a capital asset pricing model, which places a premium on a lack of correlation even if returns aren't robust. This could prove to be particularly valuable this year since prognosticators are expecting the global marketplace to be just as volatile as it was in 2011, if not more.

Institutional investors have also turned to hedge funds in the wake of historically low interest rates, which are preventing them from reaping as much as they need to from their risk-free treasury assets or fixed income investments.

And hedge funds aren't the only alternative that institutions have opted for. The challenging landscape has driven some institutional investors to pour money into alternative assets like private equity, real estate, restricted stock and warrants.

Nevertheless, a story in today's Wall Street Journal about South Carolina's public pension fund is throwing conventional wisdom on its head. The newspaper says that after years of paying high fees and dealing with complex terms that are usually incomprehensible to average taxpayers, the state's pension system is looking to scale back its reliance on alternative investments.

From WSJ:

Curtis Loftis, a 53-year-old pest-control company owner who was elected South Carolina's treasurer in 2010, is one of the few public-pension officials in the U.S. trying to trim back "alternative" investments. Most public pension funds are struggling to hit annual return targets of about 8%, an especially daunting goal given the slim returns lately on stocks and bonds.

Mr. Loftis, a Republican who also is a chairman of Mitt Romney's presidential campaign in South Carolina, says he is fed up with years of high fees on the state's hedge-fund, private-equity and real-estate investments, and their complex terms, which he says are incomprehensible to the average taxpayer.

"I question whether Wall Street's interests are being protected or our interests are being protected," says Mr. Loftis.

He is calling for a review of South Carolina's deals with private-equity firms and hedge funds and proposes cutting the state pension's exposure to those and other nontraditional investments by about half.