VideoLast year, Bill Einhorn finally had enough. With 2002 drawing to a close, the $1.1 billion pension fund that Einhorn administers for the Teamsters union in Philadelphia was set to post its third straight year of lackluster investment returns up a measly 2 percent in 2000, flat in 2001, and down 5.98 percent in 2002. During that time, it had slid from being more than 90 percent funded to only about three-quarters funded. Now, all the analysis Einhorn could put his hands on was telling him that returns on fixed-income investments — the only portion of his portfolio that had been making money in the past couple of years — were heading toward single-digit levels.
His decision: dip a toe in alternative investments. With the agreement of the board of trustees, Einhorn took 5 percent of the fund's portfolio out of fixed income and put it into private real estate investments managed by New York-based General Motors Asset Management (GMAM), the $100 billion-plus (in assets) pension arm of General Motors Corp.
"What we were looking for was a higher return with some additional risk, but not too much risk, to help us meet our 7.5 percent earnings assumption," says Einhorn, who until this year had his fund's assets split 60-40 between publicly traded stocks and bonds. (The Teamsters checks its earnings assumption every five years; the current assumption was set in 1998.) As administrator of the Teamsters Pension Trust Fund of Philadelphia and Vicinity, a multiemployer plan that covers more than 27,600 active and retired union members, Einhorn had begun evaluating private real estate as an investment option in the first quarter of 2002. He signed papers committing to the investment in December, and in February 2003 he oversaw the fund's first infusion of capital into the limited-liability corporation that GMAM set up to manage the investment, a real-estate portfolio diversified by market sector and geography.
Einhorn may well achieve his objective, assuming he hasn't bought in at a market top. Over the past 3 calendar years, private real estate has generated average annualized returns of 8.73 percent, according to the National Council of Real Estate Investment Fiduciaries, versus an annualized loss of 14.57 percent for Standard & Poor's 500 stock index. Over the next 15 years, private core real estate should earn about 7 percent a year net of management fees, predicts consulting firm Frank Russell & Co., just under the 8.1 percent expected for an indexed portfolio of U.S. equities.
Whatever his timing, Einhorn is clearly not the only plan sponsor confronting a funding crisis, nor the only one casting around for fresh ways to invest pension monies. Thanks to slumping equity markets, companies in the S&P 500 saw their aggregate pension assets shrink by $173 billion from 1999 through 2002, estimates Credit Suisse First Boston. The average S&P 500 corporate pension plan lost 8.65 percent in 2002 and 7.37 percent in 2001, according to CSFB.
At the same time, declining interest rates drove up the present value of the S&P 500's collective pension obligations by $289 billion, leaving those plans underfunded to the tune of $216 billion. Further declines in interest rates since then have exacerbated the problem. Now, many corporations that enjoyed a pension funding "holiday" in the 1990s are confronted with having to make sizable contributions to their plans.
Fearing that neither equities nor fixed-income investments will generate the returns they produced in the past two decades, many plan sponsors are looking at alternative investments — a term generally applied to hedge funds, real estate, and private equity — to juice up their portfolios.
Ignorance: Not Bliss
To be sure, there has been no mass piling into any of these sectors, especially by company-sponsored pension plans. The vast majority of corporate plan sponsors continue to invest their pension assets exclusively in publicly traded equity and fixed-income markets. (Government-sponsored pension plans have been quicker to embrace alternative investments, and endowments and foundations have been even more aggressive.)
Still, data from consulting firm Greenwich Associates indicates that among large corporate pension plans, allocations to hedge funds doubled last year, to 0.4 percent of all plan assets, while allocations to real estate rose from 2.1 percent of assets to 2.3 percent. Among plans that have gone so far as to make a strategic commitment to alternative assets, actual allocations to hedge funds typically range from 0 to 2.5 percent, while allocations to real estate generally range from 5 to 10 percent, according to Barry McInerney of Mercer Investment Consulting in New York. (Private equity isn't stirring the same sort of enthusiasm, at least for the moment. Returns there swooned in sympathy with the public-equity markets in the past two years, and total allocations by corporate pension plans to that sector declined from 2.3 percent in 2001 to 1.9 percent in 2002.)
No one is suggesting that all plan sponsors should follow Einhorn's lead, but consultants do suggest sponsors have a fiduciary duty to at least consider alternative investments. "Ignorance is not bliss anymore," says McInerney. "Fiduciaries need to be aware of all types of investment opportunities and understand what they are in terms of their return-risk characteristics and how they might fit into their portfolios."
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