WASHINGTON, D.C., Nov. 10, 2017— With an estimated 10,000 Americans retiring every day, pension funds are under increased pressure to maximize returns and generate steady income to meet the growing financial obligations of the country’s retirees. A recently updated study by pension research firm CEM Benchmarking, sponsored by Nareit, looks at the asset allocation and performance of 200 public and private pension funds, representing nearly $3.5 trillion in assets under management. The study provides a comprehensive review of investment allocations and actual investment performance across 12 asset groups over an 18-year period.
Key takeaways from the study, entitled “Asset Allocation and Fund Performance of Defined Benefit Pension Funds in the United States Between 1998-2015,” include:
- REITs were the best-performing asset class over the study period; Hedge Funds the second-worst. Listed Equity REITs outperformed all other 11 assets in the study, generating average annual net total returns of 11.4 percent. The Hedge Fund average annual return was the second-lowest of all assets surveyed, outpacing only U.S. Other Fixed Income, a category that included cash. If cash is excluded, then hedge funds would have been the worst performing asset class with an 18-year arithmetic average annual net return of 5.1 percent.
- REIT net returns were boosted by their low fees. Among the Listed Equity REITs, Unlisted Real Estate, Hedge Funds and Private Equity assets, Listed Equity REITs had the lowest fees, which contributed to their delivering the highest average net return. Private Equity had the highest average gross return at 13.1 percent, but had the second highest average net return of 11.1 percent because of the impact of expenses.
- Pension fund allocations continued to favor Hedge Funds and remain underweight on Listed Equity REITs. Hedge Fund allocations averaged [1.46] percent of pension fund portfolios at the start of the study period in 1998 and grew to [8.26] percent of portfolios in 2015 – a  percent increase. Listed Equity REITs were an extremely small allocation in pension plans’ portfolios in 1998 at [0.36] percent and the smallest of all allocations in 2015 at [0.73] percent.
- REITs provide optimal exposure to the real estate asset class. Both REITs and Unlisted Real Estate had low correlations with listed equity returns, highlighting real estate’s diversification benefits. Listed Equity REITs and Unlisted Real Estate were highly correlated as well, once reporting lags in Unlisted Real Estate were accounted for. The correlation between the two asset classes is 0.92, among the highest of all asset classes.
- REITs had the highest non-fixed income risk adjusted returns. Outside of fixed income, REITs had the highest Sharpe ratio measuring 0.44, which reflects the asset class’ strong returns and low average volatility. Unlisted Real Estate had a much lower Sharpe ratio measuring 0.31, reflecting lower returns and comparable volatility to REITs. Non-U.S. Stock and Hedge Funds had the lowest Sharpe ratios emphasizing high volatility and poor returns. The most volatile asset class in the study, after adjusting for valuation lags, was Private Equity.
“Listed Equity REITs once again emerged as the study’s top performing asset class with the highest average annual net return, relatively low correlations with other asset classes implying good diversification benefits, and superior risk adjusted returns,” said Alexander Beath, Senior Research Analyst at CEM Benchmarking and the author of the study. “Despite the asset class’ sustained, measurable outperformance over the past 18 years, REITs continue to represent only [0.73] percent of total pension fund asset allocations, highlighting a significant missed opportunity to generate substantial returns with lower annual investment costs.”
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About CEM Benchmarking and its Pension Fund Research
CEM Benchmarking is a Toronto-based provider of investment cost and performance benchmarking for large institutional investors, including pension funds, sovereign wealth funds, buffer funds and others. The results of this study are derived from CEM’s unique database, which contains detailed information regarding asset allocation, investment performance and investment expenses for approximately 1,000 large institutional investors around the world. The study used realized investment performance information, rather than performance data as measured by broad asset class benchmarks, providing a window into actual pension fund investment choices and their performance.