Institutional Investing: A Reassessment of Performance
Over the past decade, public pension funds and large endowments have struggled to meet their investment goals, resulting in significant underperformance against passive index benchmarks. Despite these disappointing outcomes, the oversight of these funds has often skewed perceptions by utilizing custom benchmarks, which frequently paint a rosier picture of performance than actual results.
Taking a closer look at institutional investment performance from a different angle, it becomes evident that the focus should be on whether these institutions are meeting their intended investment objectives rather than simply outperforming market benchmarks. Let’s delve into the details of public pension plans and endowments to evaluate their alignment with predefined goals.
Public Pension Plans and Endowments Investment Objectives
- Public Pension Plans:
- Actuarial Earnings Assumption: Public pension trustees prioritize achieving the actuarial earnings assumption, which serves as a benchmark for their investments. On average, large pension plans aim for an earnings rate of 7.4% per year.
- Endowments:
- Earnings Requirement: Colleges and universities aim to spend a sustainable percentage of their endowment fund to support institutional programs. This usually equates to 4.5% of the endowment value, adjusted for inflation using the Higher Education Price Index (HEPI), resulting in a 7.0% yearly earnings requirement since fiscal year 2008.
Investment Policy Choices: Active vs. Passive
Institutional investment overseers face a crucial decision when establishing investment policies. They must choose between index funds, which offer a cost-effective, passive approach, or opt for active management, including alternative assets, in the hopes of achieving higher returns. The predominant choice in recent years has been active management, with an emphasis on private-market assets, despite the substantial risk and cost associated with this strategy.
Evaluation of Active Strategy Performance
Recent evaluation of the performance of public pension funds and large endowments since the Global Financial Crisis indicates significant shortfalls in meeting their investment objectives. The active strategies adopted by these institutions have consistently underperformed, falling short by 1.3 percentage points per year for public funds and 0.6 percentage points for endowments since the GFC.
Conclusion
It is evident that institutional investors’ goals remain unmet, highlighting the need for a strategic shift in investment approaches. Rather than persisting with active management strategies that drain resources, institutions should allow the market to work for them. By focusing on meeting their earnings objectives rather than outperforming market benchmarks, overseers can pave the way for more effective and sustainable investment outcomes.
In conclusion, by adopting a more pragmatic approach guided by investment objectives, institutions can optimize their investment strategies and enhance long-term financial sustainability.
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