Lack of Diversity a Risk for State’s Pension Investments

By Kelly McCutchen

In these difficult economic times, it’s increasingly important to increase state employees’ retirement security and avoid future reductions in benefits. Yet a new study finds that the long-term investment returns of Georgia’s pension funds trail the performance of nearly every large public fund in the nation. With a January market value exceeding $54 billion, Georgia’s pension funds could be foregoing more than $1 billion in investment returns each year. The study, released in January, was initiated by the Commission for a New Georgia. The goal of its Task Force on State Investment Strategies was “to ensure that our State’s investment entities employ state-of-art policies to enhance the return on investment while remaining prudent and conservative in its practices.”

The study was conducted by Callan Associates, one of the nation’s largest independently-owned investment consulting firms, which compared the investment performance of Georgia’s pension funds to the investment performance of other public funds of $1 billion or greater in size. Over a 10-year period, Georgia’s investments underperformed 95 percent of the large public funds in the nation. The state’s 10-year overall investment return was 4.33 percent compared to a 6.26 percent return for the median public fund. (A return of 6.76 percent or higher put funds in the top 25 percent, while a return of 5.69 percent was the cutoff for the bottom 25 percent.)

The primary factor in this underperformance was not the performance of the state’s investment managers, but Georgia’s restrictions on asset allocation, the study revealed. The recommendations included loosening some of these constraints in order to improve investment returns, increase diversification and reduce risk. Specifically, the Task Force recommends Georgia should expand its asset allocation guidelines to include alternative investments such as private equity.

Surprisingly, Georgia is the only state in the nation that does not allow investment in private equity. The state’s motto is wisdom, justice and moderation, a motto that has served us well. Georgia may not be on the cutting edge of many policies, but this state also doesn’t follow every fad – like California, for example. Nevertheless, this state must take care not to fall behind the curve. That is what appears to be the case in investment policy.

Based on the latest investment returns, Thomson Financial calculates that private equity has outperformed the S&P 500 Index over three-, five-, 10- and 20-year periods.  Over the one-year time frame, private equities had fallen 7 percent over the previous12 months, compared with a 22 percent decline in the S&P 500 Index.

What about risk? Recent events confirm there is risk in every investment, from blue chip stocks to presumably safe banks. Risk is unavoidable, but a good investment strategy seeks to manage and minimize risk with diversification.

Keith Brainard, research director for the National Association of State Retirement Administrators, reinforces the point: “Diversifying into new asset classes, such as alternatives, reduces a portfolio’s overall level of risk, which helps protect against big losses and positions the portfolio for stronger investment returns.”

New Jersey last year credited its decision to invest in alternatives with preventing a loss of nearly $3 billion. William Clark, director of the state’s Division of Investment, declared the $3 billion loss would have occurred “if the portfolio’s asset allocation had not been diversified away from its historic concentration purely on equities and bonds.”

The Pension Benefit Guaranty Corporation – the federal agency that protects the retirement incomes of nearly 44 million American workers – adopted a diversified investment policy last year, to “better manage our invested assets,” said Director Charles E.F. Millard.

“Although it should generate higher returns, it also offers lower risk through broader diversification,” Millard said. “The strategy of increased diversification – including use of alternative investments – aims at generating returns, while providing superior protection against ultimate downside risks over time.” 

The Commission for a New Georgia report recommends Georgia allow up to 15 percent of its pension portfolio to be allocated to alternatives. Legislative proposals have generally recommended a more conservative rate of 5 percent. The average for large pension funds is 4.4 percent; the average for university endowments, 36 percent. In Georgia, alternative asset allocations examples include the University of Georgia Foundation at 14 percent, the Emory University Endowment Fund at 33 percent and the Georgia Tech Foundation at 40 percent.

Diversifying the asset allocation of pension funds is sound policy, sound investment management and good for current employees, retirees and taxpayers. Georgia should not be content with having one of the worst investment returns in the nation. The billion-dollar question, of course, is this: Does this state have the leadership necessary to pursue such a change during such a good buying opportunity?

Investment Performance through September 30, 2008

Fund Type

1 Year

3 Year

5 Year

10 Year

20 Year

Private Equity






S&P 500






Source: Thomson Financial / National Venture Capital Association

Kelly McCutchen is executive vice president of the Georgia Public Policy Foundation, an independent think tank that proposes practical, market-oriented approaches to public policy to improve the lives of Georgians. Nothing written here is to be construed as necessarily reflecting the views of the Georgia Public Policy Foundation or as an attempt to aid or hinder the passage of any bill before the U.S. Congress or the Georgia Legislature.

© Georgia Public Policy Foundation (March 6, 2009). Permission to reprint in whole or in part is hereby granted, provided the author and his affiliations are cited.

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